By David Skee
The governments unnecessary disruption of the bankruptcy laws will do long-term damage to the economy.
President Obamas visit to a Chrysler plant in Toledo Ohio on Friday was the culmination of a campaign to portray the auto bailouts as a brilliant success with no unpleasant side effects. The industry is back on its feet the president said repaying its debt gaining ground.
If the government hadnt stepped in and dictated the terms of the restructuring the story goes General Motors and Chrysler would have collapsed and at least a million jobs would have been lost. The bailouts averted disaster and they did so at remarkably little cost.
The problem with this happy story is that neither of its parts is accurate. Commandeering the bankruptcy process was not as apologists for the bailouts claim the only hope for GM and Chrysler. And the long-term costs of the bailouts will be enormous.
In late 2008 then-Treasury Secretary Henry Paulson tapped the $700 billion Troubled Asset Relief Fund to lend more than $17 billion to General Motors and Chrysler. With the fate of the car companies still uncertain at the outset of the Obama administration in 2009 Mr. Obama set up an auto task force headed by car czar Steve Rattner.
Under the strategy that was chosen each of the companies was required to file for bankruptcy as a condition of receiving additional funding. Rather than undergo a restructuring under ordinary bankruptcy rules however each corporation pretended to sell its assets to a new entity that was set up for the purposes of the sale.
With Chrysler the new entity paid $2 billion which went to Chryslers senior lenders giving them a small portion of the $6.9 billion they were owed. (Fiat was given a large stake in the new entity although it did not contribute any money). But the sale also ensured that Chryslers unionized retirees would receive a big recovery on their $10 billion claima $4.6 billion promissory note and 55 of Chryslers stockeven though they were lower priority creditors.
If other bidders were given a legitimate opportunity to top the $2 billion of government money on offer this might have been a legitimate transaction. But they werent. A bid wouldnt count as qualified unless it had the same strings as the government bida sizeable payment to union retirees and full payment of trade debt. If a bidder wanted to offer $2.5 billion for Chryslers Jeep division he was out of luck. With General Motors senior creditors didnt get trampled in the same way. But the sale which left the government with 61 of GMs stock was even more of a sham.
If the government wanted to sell the companies in bankruptcy it should have held real auctions and invited anyone to bid. But the government decided that there was no need to let pesky rule-of-law considerations interfere with its plan to help out the unions and other favored creditors. Victims of defective GM and Chrysler cars waiting to be paid damages werent so fortunatetheyll end up getting nothing or next to nothing.
Nor would both companies simply have collapsed if the government hadnt orchestrated the two transactions. General Motors was a perfectly viable company that could have been restructured under the ordinary reorganization process. The only serious question was GMs ability to obtain financing for its bankruptcy given the credit market conditions in 2008. But even if financing were not availableand theres a very good chance it would have beenthe government could have provided funds without also usurping the bankruptcy process.
Although Chrysler wasnt nearly so healthy its best divisionsJeep in particularwould have survived in a normal bankruptcy either through restructuring or through a sale to a more viable company. This is very similar to what the government bailout did given that Chrysler is essentially being turned over to Fiat.
The claim that the bailouts were done at little cost is even more dubious. This side of the story rests on the observation that GMs success in selling a significant amount of stock reducing the governments stake and Chryslers repayment of its loans show that the direct costs to taxpayers may be lower than many originally feared. But this doesnt mean that taxpayers are off the hook. They are still likely to end up with a multibillion dollar billnearly $14 billion according to current White House estimates.
But the $14 billion figure omits the cost of the previously accumulated tax losses GM can apply against future profits thanks to a special post-bailout government gift. The ordinary rule is that these losses can only be preserved after bankruptcy if the company is restructurednot if its sold. By waiving this rule the government saved GM at least $12 billion to $13 billion in future taxes a large chunk of which (not all because taxpayers also own GM stock) came straight out of taxpayers pockets.
The indirect costs may be the worst problem here. The car bailouts have sent the message that if a politically important industry is in trouble the government may step in rearrange the existing creditors normal priorities and dictate the result it wants. Lenders will be very hesitant to extend credit under these conditions.
This will make it much harder and much more costly for a company in a politically sensitive industry to borrow money when it is in trouble. As a result the government will face even more pressure to step in with a bailout in the future. In effect the government is crowding out the ordinary credit markets.
None of this suggests that we should be unhappy with the recent success of General Motors and Chrysler. Their revival is a very encouraging development. But to claim that the car companies would have collapsed if the government hadnt intervened in the way it did and to suggest that the intervention came at very little cost is a dangerous misreading of our recent history.
Mr. Skeel a professor of law at the University of Pennsylvania is the author of The New Financial Deal: Understanding the Dodd-Frank Act and its (Unintended) Consequences (Wiley 2010).
