Image: Abandoned building
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The Packard Motor Car Company closed down in the late 1950s. Could the Big Three face a simliar fate?
By Roland Jones
msnbc.com
updated 11/19/2008 4:43:59 PM ET 2008-11-19T21:43:59

The nation’s top auto executives are on Capitol Hill this week begging for a lifeline, but the request is just a tad more desperate for General Motors Chief Executive Rick Wagoner.

While it is almost impossible to predict what Congress will do about the industry’s controversial request for another $25 billion in aid, without federal action it’s likely that GM would be forced to file for bankruptcy protection, analysts say. A move like that could have a slew of side-effects, not least of which would be undermining car-shoppers' confidence in GM.

Earlier this month, the nation’s leading automaker revealed it is going through cash at a rate of $2 billion a month and will run out of money next year unless it receives an urgent injection of cash from Congress. GM was down to about $16 billion in cash and other available assets at the end of September, and the company says it needs a minimum of $11 billion to $14 billion to survive.

As the days pass and GM’s money burns away, a bankruptcy filing is a distinct possibility. Many analysts, commentators and even lawmakers have suggested that a Chapter 11 bankruptcy filing is the best option for GM. Under Chapter 11, GM would gain protection from its creditors while it reorganizes its operations.

Harvard economics Professor Martin Feldstein said Wednesday that bankruptcy might be needed for GM to get out of its current union contracts and become more competitive.

Making U.S. automakers like GM viable to become competitive again “is going to require restructuring the wages and benefits they pay to auto workers,” he told CNBC. “Whether that happens in bankruptcy or it’s done in another managed program, that has to happen.”

Proponents of letting GM go into receivership suggest that a “prepackaged” bankruptcy — one in which a company prepares its reorganization in cooperation with its creditors and implements it as soon as it enters bankruptcy — would allow the automaker to keep operating while it gets relief from its obligations, including its contract with the United Auto Workers union.

But GM executives and advocates for the company warn that a bankruptcy could lead to a disastrous Chapter 7 liquidation, under which the company's assets would be sold off through the court.

“This idea of a 'prepack' bankruptcy is pure fantasy,” Wagoner said in Senate testimony this week. “You’ve been talking about a Chapter 7 liquidation, which would affect the supply base, affect the other two [automakers] and ripple across this economy like a tsunami that we haven’t seen, and it seems to me like a huge roll of the dice.”

For Wagoner, any bankruptcy filing could cost him his job. If GM were to file for Chapter 11, creditors would gain new power in bankruptcy court, and they probably would look long and hard at the management team, said Douglas Baird, a law professor at the University of Chicago’s Law School.

“There’s a distinct possibility [Wagoner] will lose his job, but not because he has to,” Baird said. “The company’s creditors are the ones that own the company, and they might decide he’s the cat’s pajamas, but you might also find a lender to finance the turnaround that says, ‘I’m willing to lend, but not if he’s the CEO.’”

Video: ‘Let them go into bankruptcy’ A bankruptcy filing would not mean that GM immediately ceases operations. Typically, a Chapter 11 bankruptcy gives a company “breathing room” to work out its affairs and implement a new business plan, according to Baird. Workers can still go to work, consumers can still buy cars and get them serviced, and dealerships can continue to sell them, he said.

“You don’t just shut down and throw the asset away,” he said. “You continue to run it, but you tell the creditors they won’t get paid back in full for their investment, and you continue to operate the company as you restructure it and figure out its value.”

However, GM probably would face an extra dilemma in bankruptcy.

Typically, companies that go into bankruptcy need financing to continue their operations and meet customer needs, and GM would need a lot. Retailer Circuit City, for example, which recently filed for bankruptcy, successfully negotiated a $1.1 billion debtor-in-possession loan to keep stores open as it restructures. Lenders who provide debtor-in-possession financing to a bankrupt firm have priority over other creditors.

The concern is that in the current environment, few lenders would be willing to provide the $10 billion or more that GM would need, raising the risk of a “free-fall” bankruptcy, said Baird.

“It’s like jumping out of a plane without a parachute,” he said. “A company doesn’t have the cash to pay for its operations, and a bankruptcy judge just sells off all its assets. Companies usually do get the financing they need; even Circuit City was able to get a loan to continue operations. But there is some question about whether GM would be able to get the loan they’d need.”

In a free-fall scenario, a bankruptcy judge would determine which parts of the company should be sold to pay its creditors, Baird said. Creditors are paid on a priority scale, and common shareholders are at the bottom of the list so they typically receive nothing. Creditors at the top of the list usually take a haircut, receiving, say, 50 cents on each dollar invested.

Most important for GM would be trying to hang on to its customers, Baird added.

“You need to put in place a system where car owners’ warranties are protected,” he said. “When people buy a car they like to think a warranty will still hold in four or five years’ time. It’s different than using an airline that’s bankrupt; as long as the flights get you to your destination and back, you tend not to care what happens to the airline after that.”

It’s quite feasible that another automaker — one in a stronger financial position, such as Honda or Nissan — would swoop in and buy parts of GM in a bankruptcy. Sales of subsidiaries often happen in bankruptcy, Baird said, but they typically represent a worst-case scenario.

The bankruptcy judge would gain enormous power, determining whether the company should be broken up and sold off or reorganized to emerge largely intact, said Baird.

GM executives say the company needs a bridge loan to get the company through the downturn until auto sales pick up. But others say GM, Ford and Chrysler have too many plants, their expenses are too high and they need fewer dealerships, said Baird.

“If you have a restaurant that serves bad food and no one comes to eat, that’s a business plan problem,” he said. “In that case, you need a day of reckoning, and that’s a particular story that some people think corresponds to GM and is consistent with what Chapter 11 bankruptcy can do; it creates an environment in which you can do the tough stuff of restructuring.”

A bankruptcy would also raise questions about the solvency of GM’s pension funds. In a bankruptcy, the government’s Pension Benefit Guaranty Corp. would be on the hook to fulfill GM’s promises to pay a monthly pension to its retired workers. GM and the PBGC are reportedly in discussions over the health of GM’s two pension programs to gauge the impact of a potential transfer to the federal agency.

“The question here is whether there is a shortfall in the funding GM has put aside for this, and the answer is we don’t know, but it would not shock me if the PBGC had to pick up shortfalls in their pensions,” said Baird.

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