Why the auto makers might be allowed to go bankrupt, but not the banks

[HamdenRice]

<I'm reposting this from the Economy Forum. Please don't assume I am advocating the position indicated by the subject line; I'm explaining what I believe is the thinking is behind this possible outcome.>

I should say up front, I'm entirely in favor of some kind of bailout for the automakers.

But I can see the rationale for preventing the banks from going completely bankrupt while allowing the automakers to go through a prepackaged bankruptcy (not that I think that's wise, but I can see the logic of it).

Most people don't know what corporate bankruptcy reorganization actually is. It's pretty simple, but first, you have to understand "capital structure." There are various kinds of capital put into corporations in different form, kind of like a pyramid in terms of rights. At the bottom is common stock; then preferred stock; then junk bonds; then senior bonds; then secured bank debt; and so on. Each has more rights than the class before it and more protections in the event of bankruptcy.

At minimum, all bankruptcy means is that two things happen:

(1) The common stockholders' stock is declared worthless, and then everyone "moves over one" -- the preferred becomes common; the junk becomes preferred; the senior becomes junk; and so on.

A new apex is put on with a new infusion of money. It is given absolute security as the incentive to invest in a bankrupt company.

(2) Management is fired and replaced.

Other things of course can also happen -- like contracts (including labor contracts) can be re-opened for negotiation.

The idea is to keep the company going.

Now here is why a car company is different from a bank:

A car company produces cars. A bank produces paper in the form of securities. Those are fundamentally their products.

The car company can continue to produce cars if it goes through a quick pre-packaged bankruptcy. But a bank's very product (the paper, and above all its credibility) is destroyed if it goes through bankruptcy.

That said, I think the banks should be outright nationalized rather than bailed out at this point.

A second big difference is management. Many of the big banks' management, the people who got them into this mess, have been largely fired and wiped out financially already. The auto makers still have the same incredibly obtuse management. It might take bankruptcy to get rid of these guys who have been ruining the auto industry for the past 30 years.

I'm not convinced one way or the other whether it is crucial to salvage the auto makers' common stock and management, which would be the difference between a bailout and bankruptcy.

But the real point is that a car company can go through bankruptcy and continue to make cars (including continuing to hire the workers that build them and the suppliers who supply them).

[Winterblues]

1. You say the car makers can go right on producing cars but

When their vendors, parts suppliers ie Goodyear, RC Delco, Borg Warner, etc fail to get their money they stop shipping parts.. When that happens cars stop being built. The main aspect of Chapter 11 is relief from paying creditors which is in effect these guys..Without this support they can not continue to operate.

[HamdenRice]

2. Suppliers are given liens so they are able to continue supplying

The relief from creditors is generally from various bondholders who are forced down the chain (eg from secured to junk) and the face amount may be reduced (a cramdown).

But the whole point is to give assurances to the day to day creditors (employees, suppliers) so that they continue working and supplying.

The whole system is designed to keep the company functioning, which includes suppliers.

[MazeRat7]

3. A prime example would be the airlines...

United comes to mind. As I recall they filled for bankruptcy protection around 2002 and received approval, based on the re-organization plan, to emerge from bankruptcy protection some four years later in '06. There are others, but I don't remember the details.

They owed their creditors hundreds of millions. BUT... they still had planes, pilots, suppliers, routes, and gates... so they kept flying until they reorganized themselves to the satisfaction of the courts and creditors.

Peace,
MZr7

edit: Modified the dates of the bankruptcy (Yes I looked it up since my mind is not as sharp as it used to be) ;)