"Bankruptcy is not an option," General Motors' then-CEO Rick Wagoner said flatly last November. Less than six months later, Wagoner is gone and bankruptcy is very much an option, particularly since its competitor Chrysler recently took the plunge into Chapter 11. GM's new CEO, Fritz Henderson, has said bankruptcy becomes more probable by the day, and the Obama administration has mused out loud about the virtues of a quick and surgical bankruptcy, saying it could be the best way to return the nation's largest carmaker to long-term health.
But just how devastating would the largest industrial bankruptcy in U.S. history be to the economy and the nation, particularly as we try to recover from a searing recession? What exactly would the loss of jobs and restructuring of the country's sixth-largest company and one of its iconic brands mean?
The surprising answer is: Not as much as you'd think. GM has already made many dramatic changes over the past few years, and bankruptcy is more a technical option that would allow it to restructure under optimal circumstances. Whether GM goes bankrupt or not, it will have to do many of the same painful things to get back to economic health. That said, a GM bankruptcy would still be a landmark moment — the end of an era for an company indelibly associated with the U.S. Here's a look at how bankruptcy could affect a range of institutions and people.
How the Economy Will Take It
Under Chapter 11, the form of bankruptcy that is on the table, GM would keep making cars and workers would keep working while a bankruptcy judge helps — or orders — the parties to come to terms on how to keep going on a profitable basis. This will likely mean renegotiating labor contracts, trimming retiree benefits, and shutting down more dealerships. Speculation is that GM would be split into “good” assets (i.e., Chevy, Cadillac, and foreign operations) and “bad” ones (Hummer and Saturn). The good ones would be formed into a new company, while the bad ones would be auctioned, sold, given away, or shut down.
But GM has already done plenty of restructuring without bankruptcy, announcing plans to close down more than 2,000 dealerships, shutting down dozens of plants, creating a two-tier labor system in which new employees are paid less, and nuking the Oldsmobile and Pontiac brands in order to trim costs.
“If the prospect of bankruptcy had come out of the clear blue sky, well, that would have been a real shock,” says Charles Ballard, a professor of economics at Michigan State and author of Michigan’s Economic Future. “But this is not 1955 and the possibility of bankruptcy is not descending on us like Dorothy’s house on the wicked witch. We’ve been absorbing negative news for a long, long time.”
Beyond GM itself, though, a bankruptcy would likely have a significant impact on its approximately 1,500 suppliers of everything from transmissions to cupholders. The fear is that if GM doesn’t pay its suppliers or is allowed to pay only a small portion of what it owes, then the suppliers would go under and there would be no transmissions or cupholders for Ford or Toyota, either. That could precipitate a tsunami of bankruptcies and further closures and layoffs.
But is there an alternative scenario? Suppliers would be almost certain to be designated by the bankruptcy court as “critical vendors,” meaning they would be the first to be paid. And considering that the U.S. government is likely to own a chunk of GM, at least for a time, the suppliers could be more confident of payment under Chapter 11 than otherwise.
The Cost to the U.S. Taxpayer
The U.S. government — that is, you, me and the other U.S. taxpayers — has already poured $15.4 billion into GM. If GM is able to emerge successfully from Chapter 11 and recover, taxpayers will get that money back. If GM fails, it will be gone.
But bankruptcy itself is not cheap, and much of the cost will fall on the American taxpayer, even if GM goes on to thrive. For a start, because GM’s pension system is underfunded, the federal Pension Benefit Guaranty Board will likely have to pick up those obligations. That’s $13.5 billion right there. In addition, any bankruptcy judge is likely to look at the generous health benefits GM’s 400,000-plus retirees get and chop them down; much of those costs will then end up being borne by Medicare. And if there are additional job losses because of Chapter 11, that will mean more spending on unemployment and Medicaid, the health program for the poor.
What Happens to Employees
Under the plan announced April 27, GM will reduce the number of its North American hourly employees to 41,000 by 2010. That’s down by more than half since 2007, a brutal number of jobs destroyed in a brutally short time. In addition, the workers who keep their jobs will almost certainly be looking at lower wages and benefits since under bankruptcy, all contracts can be renegotiated and the judge can order changes if the parties are reluctant to. Will there be even more job cuts in the event of bankruptcy? Not necessarily. It will be GM’s performance that mandates the size of the payroll, not whether it is in or out of Chapter 11.
The Last Turn of the Screw on Investors
When a company goes into Chapter 11, its shares are generally delisted and shareholders lose all their remaining value. So if you own GM stock the day the company goes bankrupt, feel free to convert it into wallpaper. At the moment, GM stock is trading at just over $1 a share and its market cap is only $879 million, so the impact on investors will not be huge. But expect the Dow to react badly on the day a GM bankruptcy is announced. Even though it wouldn’t be a surprise, the market would be bound to flinch if the country’s largest automaker entered Chapter 11.
What if you own a piece of GM’s $27.5 billion in unsecured bond debt? Well, it’s likely that you’ve resisted swapping it for shares in GM; something like 90 percent of GM’s bondholders have spurned the company’s offer to do so. In Chapter 11, bondholders have to do as the bankruptcy judge says; the term for what you’ll be forced to accept is “cram down” and you’ll be lucky if you get back 20 percent of what you invested.
And What If You Drive a GM Car?
Last year, GM sold 8.3 million cars, and tens of millions of the company’s vehicles are on the highways and byways of the world. If you own one of them, life probably would not change much. In the event of a bankruptcy, the federal government has agreed to guarantee all warranties. And the people who fix cars would not vaporize. Resale values might suffer if buyers became concerned about the durability of these guarantees, but ultimately it is supply and demand and the quality of the cars themselves that will determine their worth. The big question is whether people will continue to buy cars from a bankrupt company. Former CEO Rick Wagoner has argued that the answer is no, which is why he long insisted that bankruptcy was not an option.
The British Model
None of this is to say that a GM bankruptcy would be trivial, only that things have been so bad for so long that it would be simply another in a long series of blows. And of course, a poorly executed bankruptcy would be disastrous — hammering consumer confidence and complicating day-to-day management.
Perhaps the fate that awaits the U.S. is similar to what befell Great Britain’s big carmakers starting in the late 1960s. In 1968, the British government forced a merger between market leaders British Leyland and British Motor Company. This company, BLMC, began with something like a 40 percent market share. But it had terrible labor problems and had grown complacent with uninspired designs and inadequate quality. (Sound familiar?) After several incarnations and multiple bailouts, the last descendant, known as MG Rover, went out of business in 2005. Certainly, that was a blow to national pride, but that did not mean the end of the British car industry.
Today Britain has a thriving auto sector; it just isn’t composed of British companies. Last year, Britain produced 1.6 million vehicles — but for companies from Germany, Japan, Malaysia, China, and India. Closer to home, the American South is in a similar position — lots of plants and production, but for non-American companies.
We’re a long way from that point. For all the bad news coming out of Detroit, it’s worth remembering that GM still sells almost one out of every five vehicles in the country. And the cars, by all accounts, have been getting better. While it hasn’t always been true, the fact is that it’s not the products that are broken. It’s the business model. And hard as it is to face, a “quick and surgical” bankruptcy could be the best hope we have of fixing it.