For Detroit, Chapter 11 Would Be the Final Chapter
By SPENCER ABRAHAM
MANY commentators and members of Congress have declared that the best hope for the Big Three auto companies is to declare bankruptcy. Airlines have gone through bankruptcy and adjusted, after all, so why can’t carmakers?
This comparison is appealing, but flawed. Almost every carmaker that has ever gone bankrupt has disappeared for good. And there is no reason to believe the Big Three would not do the same. Chapter 11 filing would almost surely lead to liquidation.
Just as financial institutions depend on the confidence of those with whom they do business (as Bear Stearns and Lehman Brothers discovered), automakers depend on the confidence of car buyers. To purchase a car is to make a multiyear commitment: the buyer must have confidence that the manufacturer will survive to provide parts and service under warranty. With a declaration of bankruptcy, that confidence evaporates. Eighty percent of consumers would not even consider buying a car or truck from a bankrupt manufacturer, one recent survey indicates. So once a bankruptcy proceeding got started, the company’s revenue would plummet, leading it to hemorrhage cash to cover its high fixed costs.
That would thwart any attempt at reorganization, and the case would likely move inexorably toward liquidation under Chapter 7 of the federal bankruptcy code. Debtor-in-possession financing — which is what the bankrupt need in order to pay for the continued operation of their business — would not be available in the vast amounts required, given the plunge in revenue.
A bankruptcy filing by even one of the Big Three would probably set in motion a cascade of smaller bankruptcies by suppliers of car parts, as the money the company owed them (which would be classified as an unsecured claim) could not be paid until it exited bankruptcy. And this loss of suppliers would almost certainly overwhelm the other two carmakers. There would also be a severe contraction in the availability of trade credit from suppliers, which amounts to tens of billions of dollars.
And as surely as day leads to night, bankruptcy proceedings would be followed by liquidation. In a flash, the American carmaking business, representing about 10 percent of the nation’s retail sales, would begin to disappear.
For those concerned about the potential price of a federal bailout for Detroit — and I’m one of them — the reality is that this cost would be dwarfed by the long-term spillover costs of bankruptcy and liquidation. Nearly three million jobs would be lost in the first year if all three car companies closed and their suppliers absorbed the shock, according to the Center for Automotive Research. That would mean tens of billions of dollars in pension liabilities would be transferred to the Pension Benefit Guaranty Corporation, the federal insurance fund that protects the pensions of nearly 44 million American workers but already has a $10.7 billion deficit.
We’d also see an influx of Americans who have lost their health insurance onto the rolls of Medicare and Medicaid, costing billions of dollars more. And the budgets of the so-called “auto states,” mainly in the Midwest, that depend heavily on the domestic car manufacturing industry would be wrecked, and that would likely lead to both higher taxes and depressed economic growth.
Bankruptcy would also deliver a painful shock to the country’s already damaged financial system, which draws significant revenue from, and has significant credit exposure to, auto loans. For the past decade, an average of roughly eight million vehicles made by General Motors, Ford and Chrysler have been sold annually. That translates into about $190 billion in auto financing each year. Given that the average life of an auto loan is two years, an estimated $350 billion to $400 billion worth of exposure is thrashing around our financial system. And the value of this paper would drop along with the value of the cars.
Regional and national banks, as well as credit unions and finance companies, hold these loans on their balance sheets. Banks also have exposure through investment vehicles whose value is tied to car loans. And the pain would be intensified because the banks have not hedged their exposure to auto loans.
There’s no denying the American auto companies have made major mistakes, by over-investing in S.U.V.’s, for example, and failing to quickly streamline their manufacturing. But allowing one of them to file for bankruptcy would be a disastrous course.
If we knew then what we know now about the systemic shock to our economy, would we have allowed Lehman Brothers to go bankrupt? Absolutely not. If we let any of the Big Three go bankrupt, we will set in motion a chain of events that will cause us, in six months, to ask again: How did we let this happen?
Spencer Abraham is a former United States secretary of energy under President Bush and a former United States senator from Michigan. He is the chairman and chief executive of the Abraham Group, which advises energy and investment companies, and is a board member of Occidental Petroleum.