How Bankruptcy Would Wreck GM, Chrysler

The economy is so bad in parts of Detroit that a home there recently sold for $1. For the automakers based nearby, it's not looking much better.

Car sales are in a tailspin on account of $4 gas and a swooning economy, and as usual, the Detroit automakers are suffering more than their competitors. Overall, sales are down about 11 percent so far this year, according to J.D. Power & Associates. But at the Detroit 3, sales are down an outsized 18 percent. The biggest reason is an overreliance on big trucks and SUVs and a dearth of small cars that consumers actually like.

Ford (F) has been hit hard, but looks to have enough cash to ride out a worst-case downturn and survive until 2010, when the market should rebound and recent labor cutbacks will start to pay off. But cash-flow problems are more precarious at General Motors (GM) and Chrysler, where analysts think a Chapter 11 filing is a serious possibility if the car business stays weak through 2009. To some, that seems like no big deal: Other companies, including four big airlines, auto-supplier Delphi, and retailer Kmart have used bankruptcy to rein in bloat, slash costs, and get healthier.

But for GM or Chrysler, declaring bankruptcy would be more like slashing their own tires. Customers would flee, consumers would be unsympathetic, and the government would probably do little to help. Here's why bankruptcy would be such a dire scenario for any one of the Detroit 3:

Buyers would bail. When airlines like United, Delta, and Northwest declared bankruptcy, most fliers stuck with them. That's because it was clear those airlines would stay in business at least long enough to honor their tickets. But it wouldn't work that way for an automaker. Most people who buy airline tickets plan to use them within weeks. But consumers spend way more on a car than an airline ticket, and commit to the product for years. It's kind of important that the company selling the product be around to make good on a 60,000-mile warranty, service the car, and supply parts.

Simply declaring bankruptcy would be a disaster for an automaker, even if the company seemed likely to ultimately survive. In a survey conducted by CNW Marketing Research, 80 percent of people close to buying a new car said they would abandon an automaker if it were to file for bankruptcy. Not surprisingly, the numbers were higher for the Detroit 3, and lower for most foreign makes. An automaker could forestall the doom somewhat by offering fire sale prices—but selling cars at a loss would only perpetuate underlying profitability problems. "In today's marketplace, bankruptcy for General Motors (or any major automaker) is a death knell," CNW concluded in a recent newsletter.

Bankruptcy wouldn't solve much. For airlines and other big companies that have successfully emerged from bankruptcy, Chapter 11 allowed them to cut costs and other expenses they were unable to address under normal operations. The airlines, for instance, were able to slash pensions and renegotiate rich labor contracts that were signed when the airlines were flush, but which they could no longer afford. That improved cash flow and helped them get back on their feet.

The automakers, by contrast, don't have a major problem funding their pensions. And they've already negotiated deep wage and job cuts with their unions, and cut billions in costs. "They're not being crushed by wage and benefit costs," says Mark Oline of Fitch Ratings. "It's about revenue and products now. It's a business model issue."

Bankruptcy might allow Chrysler or GM to offload some debt—but it wouldn't do anything to increase revenue, speed the arrival of must-have new products like slick compact cars and family-oriented crossovers, or fund technology breakthroughs like GM hopes the Chevy Volt plug-in hybrid will be.

Bankruptcy is such a dire scenario that analysts think GM would first sell off whole divisions, like perhaps Saab or Saturn, in addition to the Hummer franchise it has already put on the block. Chrysler's most valuable assets are the Jeep brand and the Dodge Ram pickup, product lines that could be melded into another automaker. Chrysler, which is now owned by private-equity firm Cerberus Capital, has been a particular curiosity. As a private firm it no longer has to report financial details to the public, and some analysts think it may already be operating close to the brink of insolvency. Oline expects Chrysler to start refuting such speculation with more transparent financial reporting.

A government bailout seems unlikely. At least a big one does. GM and Chrysler combined control just 30 percent of the U.S. market today, a nose dive from the days when the domestics dominated the industry. GM is fending off Toyota for the U.S. sales lead; Chrysler, once one of the "Big 3," is now No. 5 in the United States. And American-built cars from Toyota, Honda, and other "importers" now make up a sizable chunk of overall sales.

Translation: Aside from the Michigan delegation in Congress, there's little government appetite for an automaker bailout. "There's not the mood to do it," says one industry lobbyist. "People feel like the Detroit 3 dug this hole and they've got to get themselves out." A test case will come this fall, in a bill that contains $6 billion in low-interest loans for domestic automakers to retool aging factories. The bill still has to get through Congress, and if it does there's no sign yet whether President Bush will sign it or threaten a veto.

Neither company is too big to fail. When the Federal Reserve rescued a rump Bear Stearns earlier this year, the financial firm was a fraction the size of GM. But regulators feared that if Bear Stearns failed, a daisy chain of called loans, bank runs, and subsequent failures could swamp the entire financial system. The same logic applies to Fannie Mae and Freddie Mac, the huge mortgage funders that underwrite nearly half of all U.S. mortgages and now seem to be approaching insolvency; if one or both collapsed, the collateral damage would be deep and widespread.

That wouldn't happen in the auto industry if GM or Chrysler went down. No doubt there would be more job losses and financial pain, but it would probably be confined to the Rust Belt and other areas where the Detroit 3 were once dominant. As a private company, Chrysler would hardly be in any position to ask for government aid. And if either company did ultimately declare bankruptcy, it would probably happen at a time of deep Bailout Fatigue in Washington.

There's one other unsettling prospect: The market may not even need three domestic automakers. In fact, the quick shrinkage or even disappearance of a big carmaker might solve an oversupply problem: An industry that built and sold almost 17 million vehicles in 2004 and 2005 will be lucky to sell 14 million in 2008. And there's no guarantee that sales will bounce back to levels that many thought amounted to a mini-bubble. That sharp reduction can be spread across all the players—or borne by a few of the most beleaguered. Which is what seems to be happening.

Disclosure: none

Comments

[leisureworld:]

Mr. Newman seems to forget that Chrysler has already gone down this path in 1979. Although Chrysler never officially declared bankruptcy, it was essentially insolvent. Customers didn't exactly run from the company, but rather embraced Iacocca's buy American theme. It remains to be seen whether a repeat will occur.

2008 Aug 24 07:37 AM

[leisureworld:]

Mr. Newman seems to forget that Chrysler has already gone down this path in 1979. Although Chrysler never officially declared bankruptcy, it was essentially insolvent. Customers didn't exactly run from the company, but rather embraced Iacocca's buy American theme. It remains to be seen whether a repeat will occur.

2008 Aug 24 07:37 AM

[seabell:]

Can you all find something positive to write about? Be it autos, banks, etc., everyone knows about the troubles. There are some good things going on in the financial and automotive world that no one knows about.
How about some positive spins for a change. Let's get this country thinking great again!

2008 Aug 24 09:21 AM

[USAFORSALE:]

Mr Newman thinks a failure in a financial institution would have greater impact than failing US manufacturing. Financial institutions simply facilitate market trading and savings. Manufacturing adds value to society with products.

As long as people are throwing opinions around, no one wins. When I throw facts at the uninformed foreign supporters, they eventually realize they are sheep headed for the slaughter. The Japanese are not here because they like us. They are taking over.

Toyota has 6 US assembly plants. GM has 27 US assembly plants with nearly 80 total US manufacturing facilities. GM has more assembly plants than Toyota(6), Honda(7), Hyundai(1) and Nissan(6) COMBINED.

GM employs over 120,000 workers. More than all foreign manufacturers COMBINED.

GM employs 20 college graduates for Toyota's 1.

GM creates millions of indirect jobs through domestic parts content.

GM has nearly 80% domestic content. Toyota has only 40%

Most of the jobs are in the parts which come from Japan. Think of a radio. At the assembly plant a few screws and wires are attached. Most of the jobs are related to the complex internals of the radio (circuit boards, switches, displays, programming, etc). Even if the radio is assembled by Panasonic America in US, the parts are brought over in bulk assemblies with very little work in US. If you dig deep into Toyota "domestic" content you will find Yazaki America(wiring), Panasonic America (electronics), Denso America(electronics), Takata America (safety). These are all American subsidiaries of Japanese corporations which give them credit for American content. More deception.

The Japanese are buying America. We buy products (decent products) and they take the money and buy more of our country. Harmony Agricultural Products is a subsidiary of Honda. They are buying thousands of acres of American farmland and American farmers pay them rent. GM is not buying farmland in other countries or even in America for that matter. GM is trying to promote ethanol a fuel which American farmers can produce.

Is this what our grandfathers died for in WWII. So we could trade our land for Sony TVs and Japanese cars. If they tortured our forefathers in WWII 70 years ago, are we comfortable with them owning our country and taking care of our grandchildren 70 years from now. Talk to someone who works at Toyota engineering in US. All the science is maintained in Japan. They want to control knowledge and use us as assembly workers and for easy engineering tasks. When they own everything we will beg for work from them like slaves. This is already happening. People want jobs (of course) but the opportunities are greater for Americans at American companies. Their careers are limited at Toyota because they are not Japanese (the rice paper ceiling). They create a few exceptions which they parade around on TV and in the media to fool people into trusting them.

DIG deep into the deception of Toyota and Honda and you will see the wolf in sheep clothing. They are buying America.

2008 Aug 24 09:28 AM

[ksmithdc:]

Agreed - re: the similarity w/ 1979. These things seemingly go in cycles. I don't think $4 gas is a permanent thing. Expanded harvesting of petroleum coupled with diminished demand plus expansion of alternative fuel sources = lower costs.

2008 Aug 24 11:07 AM

[sportsfan1999:]

Does anyone find it odd that we would trust our lives to a bankrupt airline, but few would buy a car from a bankrupt automaker?

2008 Aug 24 12:41 PM

[casey00001:]

The precendent has already been set. Since Chrysler was bailed out, Ford and or GM would certainly get Federal Backed Loans to keep them solvent. The US economy could not stand to loose either one. I am not worried in the least.

2008 Aug 24 03:30 PM

[notsosmart:]

sadly-the mess we are in is the mess we created.how silly,in this world,at this time to blame the foreigners.i dont like buying chinese goods & i would & have(when possible) paid more for american made. thats not what the ruling class(big corp.& us govt. want. i buy good s from china because i have to.i cant find much made here anymore.

2008 Aug 24 08:50 PM

[fiveamericans:]

Did he really use the phrase "on account of" in the second paragraph, I ask rhetorically?

Gee Wally - I didn't drink my milk on account of it tasted bad.

I know Beav, but your lucky Dad didn't haul off and sock ya one!

After that, it was difficult to take the article seriously on account of the lack of fact-based conclusions that followed.

2008 Aug 25 12:10 AM

[John Delano:]

This article sure reminds me of Karen DeCoster.

2008 Aug 25 02:35 PM