Bailouts and Bankruptcies: What’s the Right Thing to Do?

I’ve started to wonder if this blog is still about LEADERSHIP – its original mission – or if it’s about cars. My last entry (Clint vs. Karl: Yeah, But What About the Cars?) focused on the validity of Chrysler’s claim in their "Halftime in America" ad on the Super Bowl. My assertion – that cars manufactured by the Big 3 are every bit as good as the foreign competition -- has since been borne out J.D. Power & Associates. Their most recent survey of the reliability of three year old cars ranked four American brands in the top 10 (Ford, Lincoln, Buick and Cadillac) and clearly observed that there are no more poor quality cars sold in America. Even those at the bottom of the survey’s list report very few problems and their reliability was not significantly different (statistically speaking) from those at the top of the list.


Most respondents to the posting told stories of cars they have owned for a long time, ranging from an ancient Land Rover Defender to a classic 68 Olds to a late model Chrysler 300C. Others lamented the fate of GM, a once great American manufacturing company.

One response, from my old friend Bob Cannan, stood out because it addressed the GM and Chrysler bankruptcies. While Bob conceded that the Chrysler ad was just that (an ad to sell cars), he continues to be disturbed by the government’s bailout of 2 of the Big 3.

“I think what I and others worry about is the idea that the American people, who understandably would mourn the loss of the American auto industry, will now come to believe that the ends have justified the means. The government, in other words, saved Chrysler and GM.” Said Bob. Going further, he protests:

“But this could have been done, and should have been done, by conventional bankruptcy.

“In conventional bankruptcy, a judge could have called all contracts into view, including the union’s. I’m sure that a restructured GM, emerging from the court of a skilled bankruptcy judge would have been much stronger than the one we see today. And the process would have been legal.

“Instead, the rights of bondholders and existing stockholders were violated. It’s grand larceny in my opinion. Repugnant. Reprehensible. The stock was distributed to the unions. Directly.”

For the most part, I agree with Bob. Indeed, I would take it a step further. The seeds for the current public expectation, that government will step in, were sown by the original Chrysler bailout in 1980. If Chrysler had been allowed to fail then, how much stronger might the rest of the industry have been in 2008? That bailout was the first step on the proverbial slippery slope.

That said, I think that the period of time between the Lehman bankruptcy and the GM bankruptcy -- a period of about 9 months -- was one of the most extraordinary of our lifetime. I believe it was George W. Bush who said, "I’ve abandoned free market principles to save the free market system." It's now easy to analyze the mistakes of the 9 month period in question. However, when we were in the middle of the storm, the fear of collapse dominated everyone's mentality.

What about the assertion that it was not legal?

We often hear that our nation is governed by the “rule of law”. The founders ensured that the elected legislature made the rules and not a sovereign. In the minds of many, “rule of law” conjures images of criminals going to jail. However, its most common application is the execution of contracts. In the case of GM and Chrysler, those contracts were loans, corporate bonds, supplier purchase orders and union agreements.

A Bankruptcy Court is not a court of law; it is a court of equity. In simple terms, the judge gets to decide what’s fair and equitable. It doesn’t matter what the contracts say. In a sense, they break the law by setting aside existing contracts.

In the GM bankruptcy, there was no commercial lender – bank, private equity fund, non-bank lender – who could or would step in to finance the company’s continuing operations. So, rather than let GM fail, presumably taking down much of the supply chain with it and putting hundreds of thousands of people out of work, the government stepped in as the Debtor in Possession (DIP). Were it not for their loan during the GM bankruptcy proceeding, GM would have ceased to operate. For most companies, that would have meant liquidation.

Would a willing buyer have stepped up to acquire the Buick Division or Cadillac? Not likely. Not then anyway.

More often than not, the DIP is also the ultimate buyer. And, the buyer’s desired outcome is usually the key factor in determining the final deal that is approved by the bankruptcy judge. So, the government structured the outcome.

When the government gets involved in business, the results get distorted. In this case, the distortion took the form of an allocation of a significant share of GM to the UAW. Believers in free market capitalism find this reprehensible as do I.

So, what do you think? If the government hadn’t stepped in to save GM and Chrysler, would the economy have collapsed? Moreover, was the GM bailout an example of extraordinary LEADERSHIP in a time of crisis or a nail in the coffin of the American free enterprise system?