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A Detroit Bankruptcy Beats a Bailout

Not content with $25 billion in government loans to retool factories for fuel-efficient cars, the auto industry is already back at the trough, this time angling for a taxpayer investment in the firm that would result from a merger of General Motors and Chrysler.

You can just imagine the pitch from the populists of the Michigan congressional delegation: If the government is willing to invest $250 billion to bail out pinstriped bankers, then the least it could do is throw an extra $10 billion to rescue the domestic auto industry and the millions of workers and retirees who depend on it.

There's only one difference: The government will make money on its bank investment, while the GM-Chrysler deal is a lemon.

As reported by Reuters, GM and Chrysler would have the Treasury invest $3 billion directly in the newly merged automaker in exchange for preferred shares with warrants, as with the banks. The government would take over $3 billion of the company's pension obligation. To deal with the industry's short-term liquidity problem, the government would also commit to buying $4 billion in commercial paper issued by the new company.

All that for two companies whose market values today are each less than $4 billion.

The rationale for this scheme is pretty simple: If nothing is done, the financial situation of both of these companies is so dire that one or both of them will be forced to file for bankruptcy protection in the next several months. And a bankruptcy filing, we are told, will send an already weakened economy over the cliff, wiping out 2 million jobs, shifting tens of billions of dollars in pension obligations to the government and lopping two percentage points off the nation's gross domestic product.

Although somewhat exaggerated, there is a kernel of truth in this doomsday scenario: This would be a particularly bad time for the U.S. economy to have GM or Chrysler go under. It would have devastating effects on many communities in the Midwest, deal another blow to consumer and investor confidence, and put further strain on already shaky government budgets.

But even with a government-financed merger, the companies are going to have to shrink by at least 25 percent to reflect the realities of a shrinking market and much-reduced market shares. That translates into the direct loss of an additional 40,000 jobs and the indirect loss of several hundred thousand more. There is simply no way to avoid this pain without making the company a permanent ward of the federal government.

The real flaw in the government-financed merger proposal is that it spares the companies from bankruptcy reorganization, the very process they need to get their costs and structure in line with market realities.

Only a bankruptcy court can reduce the burden of pension and health benefits to 600,000 retirees that are slated to cost the companies $90 billion over the next decade.

Only a bankruptcy court can override the state laws that make it difficult and expensive for Chrysler and GM to pare back a combined network of 10,000 dealerships, about 10 times more than Toyota has in the United States.

And only a bankruptcy court can impose on members of the United Auto Workers pay and benefit packages comparable to those paid at the nonunionized plants of foreign manufacturers that have been stealing market share from the Big Three for decades.

If the Treasury were to commit government funds without getting this kind of long-overdue restructuring, it would simply be throwing good money after bad.

But that's not all. Taxpayers should also demand that the Treasury take the same hard line in negotiating a rescue for the automakers that it took in structuring the rescues of Fannie Mae, Freddie Mac, AIG and Bear Stearns.

Equity holders of both auto companies -- including Cerberus Capital Management, the hedge fund that purchased Chrysler from Daimler with very little of its own money -- should be wiped out, or at most given a small stake in the new company.

Creditors should get only 30 or 40 cents on the dollar owed -- about what the debt is selling for now -- plus an equity stake in the new company.

And top management of both companies should be shown the door, along with most of the directors, in recognition of their failure to deliver for shareholders and creditors.

All of these terms -- the cost-cutting, the dealer restructuring, the haircuts for shareholders and creditors, the management changes -- can be negotiated upfront and presented as a done deal to the bankruptcy court. Such a "prepackaged" bankruptcy would allow GM-Chrysler to run through the reorganization process in a matter of a few weeks or months without missing a payroll or a day of production. It would save as many jobs as can reasonably be saved and preserve what value is left in the companies, while giving taxpayers a reasonable chance of earning a return on their investment.

Honestly, I don't know if the GM-Chrysler merger makes a lot of business sense. The promised savings of $9 billion a year are overblown -- as far as I can tell, most of that represents reduction in capacity that could just as easily be accomplished by the companies separately as together. At the same time, in an industry that has gone from producing 17 million vehicles a year to 12 million, some consolidation is probably inevitable.

What I do know, however, is that's it's time for Michigan's senators and congressmen and governors to stop shilling for Wall Street creditors and shareholders and defending managers and unions that stubbornly ignore market realities. For years, these politicians did the bidding of the Big Three by pushing a protectionist agenda and fighting off attempts to impose reasonable fuel-efficiency standards -- and the result is that all three companies now stand on the brink of financial collapse.

This time, they owe it to their constituents and the country to back a painful but credible strategy to save the industry rather than one that simply bails out the industry from another mess of its own creation.

Steven Pearlstein can be reached [email protected].
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