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How to Help Detroit

Thursday, December 11, 2008

Why declaring bankruptcy is the least bad option for the Big Three automakers.

Everyone agrees that the Big Three automakers are in serious need of repair. But who should repair them? The two prime candidates are bankruptcy court and the federal government.

The carmakers have been vehemently opposed to bankruptcy. It would wipe out their existing shareholders, of course, but that’s not why the auto giants say they oppose it. Instead, they complain about the negative stigma that goes along with being an officially bankrupt company. But car customers are not fools. In judging the health of a Big Three auto company, they are likely to draw on all available information, not least the recent barrage of negative press coverage. Nor is it likely that a short-term bridge loan from the federal government would assuage all the worries customers might have.

It is unclear just how much money is necessary to keep the Big Three afloat; but an overly generous government bailout package would reduce the pressure on Ford, GM, and Chrysler to implement essential reforms. The auto companies initially came to Washington seeking $25 billion. They were roundly chastised for their past failures and told to amend their request. Two weeks later they were back with plans to use $34 billion in public money.

What the Big Three need most is restructuring. They face three overarching challenges, none of which the federal government is well equipped to supervise.

With demand for American cars plunging, the industry is saddled with too many factories and too many dealerships.

The first challenge for Detroit is to reduce capacity. With demand for American cars plunging, the industry is saddled with too many factories and too many dealerships. Closing factories and dealerships will impose pain on local communities. What are the federal government’s qualifications for taking on such a task? In recent years, the proposed closure of various military bases proved so controversial that Congress decided it couldn’t handle the issue and outsourced the decisions to an independent commission.

The second challenge for Detroit is to rewrite its labor agreements. The Big Three have been burdened by higher labor costs than their foreign competitors, even those producing cars in North America. Ford, GM, and Chrysler have also paid a steep price for the longstanding generosity of their health and retirement benefit plans. Is it realistic to expect that the federal government would demand a harsh reduction in those benefits? According to the Bureau of Labor Statistics, union membership is nearly five times greater in the public sector than it is in the private sector; and the Democratic Congress will find it exceedingly difficult to take on the United Auto Workers.

The third challenge for Detroit is to focus on profits. When a company is flush with cash, it can afford to squander its resources on vanity projects. When a company is fighting for its very survival, it must have the discipline to forswear all distractions in its pursuit of profitability. Would the federal government allow such a ruthless drive for efficiency? Or would it insist that the Big Three boost production of less profitable “green cars”? The recent congressional debate has answered these questions for us.

The government should be kept as far away as possible from Detroit’s actual restructuring.

An additional challenge for Detroit, should these efforts falter, would be to sort out the competing demands of creditors. By definition, a bankrupt company is not able to satisfy every bondholder and bank who has a claim. Congressional leaders have suggested that if the auto industry is insufficiently zealous in its restructuring, it would have to repay the latest loans from the government. But with what money? And whom would the industry pay first, the feds or the banks? Attempts to legislate an answer raise serious questions about the constitutional guarantee of due process. It is exactly for this reason that we have bankruptcy courts.

To be sure, a prepackaged bankruptcy could require some government involvement. Given the current turmoil in credit markets, government guarantees might be needed to procure “debtor in possession” financing. But the government should be kept as far away as possible from Detroit’s actual restructuring. The less meddling by the government, the more likely that such restructuring will be successful.

Philip I. Levy is a resident scholar at the American Enterprise Institute.


Image by Darren Wamboldt/Bergman Group.


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