PRIDE IN AUTO SECTOR TURNS TO SCORN – There was a time when the U.S. car business was the envy of the world

Posted by Gilmour Poincaree on November 23, 2008

Published: Friday, November 21, 2008

by Nicolas Van Praet, Financial Post

Factories in the United States and Canada pumped out stylish and solidly built cars like the Ford Mustang and Chevrolet Corvette that captured the public imagination and became symbols of middle-class optimism. Every country wanted a Detroit. Every American was proud of Motor City’s muscle.

Today, that pride has turned to scorn in many corners of North America.

Burning through cash as vehicle sales stall in the United States and Europe, General Motors Corp., Chrysler LLC and Ford Motor Co. are asking for taxpayer-backed emergency relief of US$25-billion in the United States and as much as US$6.5-billion in Canada.

But many people say they don’t want to rescue car companies from which they would never buy a vehicle. Many argue Detroit is the architect of its own misfortune, clinging too long to big trucks while its customers wanted small cars, and bending to union demands for higher compensation while international automakers in the United States pay their workers much less.

Detroit’s automakers say they absolutely need government aid, that reorganizing their businesses under bankruptcy protection is not an option. They say they would be forced to liquidate instead, resulting in at least three million lost jobs.

But the companies are being met with more than a few mistrustful lawmakers who appear willing to call their bluff. And, in the end, bankruptcy court may be where they find themselves.

“The automakers and the government are playing chicken right now,” says Mark Bane, a bankruptcy lawyer with Ropes & Gray LLP in New York.

“You have to draw a distinction between what the automakers are saying to frighten people into giving them money and what the truth is,” adds Alan Schwartz, a professor specializing in corporate finance at Yale University. “I don’t see any particular reason why bankruptcy would be bad for these companies.”

What is it about the auto industry that makes it so special? U.S. and Canadian airlines have undergone restructurings under Chapter 11 and Canada’s Companies’ Creditor Arrangement Act – and emerged successfully. Massive companies like Kmart Corp. and Cadillac Fairview Inc. have filed for bankruptcy and are still in business.

Why would GM or Chrysler be any different?

Pressed under questioning in congressional committees this past week on whether they have examined bankruptcy protection, chief executives with all three automakers acknowledged they have weighed the possibility as a way out of their distress.

Alan Mulally, Ford’s CEO, said it’s simply “not a viable option.”

GM chief executive Rick Wagoner, whose company has indicated it may lack the cash to fund daily operations by the end of this year, used apocalyptic language in his assessment of a bankruptcy filing. It would lead to “massive economic devastation,” he said, because consumers would stop buying GM vehicles, its dealers would collapse, the supply chain would buckle and other manufacturers would also see their output paralyzed. “You would end up liquidating the company very simply because you wouldn’t have revenue.”

Independent research by CNW Group in Bandon, Oregon, supports Mr. Wagoner’s view. In a survey of 6,000 people who planned on buying a new car within six months, more than 80% of them said they would not choose an automaker if it were to file for bankruptcy.

In today’s marketplace, “bankruptcy for General Motors or any major automaker is a death knell,” CNW said.

“People buy from bankrupt companies all the time,” Mr. Schwartz says. “When you go bankrupt, you don’t disappear.”

Intervening with a direct bailout in what should be the natural outcome of market forces would be a mistake for governments, Mr. Schwartz argues. In Europe, companies in financial difficulty can apply to the European Union for a subsidy that may save them, he notes. “What we do in the U.S. is we let them fail. And we’ve had very good success with that model.”

With capital markets frozen, it would be difficult for GM or any automaker to win financing for a new lease on life through a bankruptcy filing, Mr. Schwartz says. He says a more appropriate role for governments may be to provide debtor-in-possession financing, because it would give the government priority over other lenders while ensuring a level of restructuring takes place.

Mr. Bane, the bankruptcy lawyer at Ropes & Gray, is among those pushing for a prepackaged bankruptcy for GM. In a prepack, as lawyers call it, the company would enter court with financing already arranged after striking a deal with lenders, employees and suppliers outlining concessions each party would give and what a new GM would look like. What might take more than two years or more under a regular Chapter 11 filing might take 12 months or less.

Such a deal could be struck if a deadline were set, he says, and government could give GM financing for the exclusive purpose of completing the prepack. “Once you have true parameters and you’ve also provided the financing to allow General Motors to do this kind of exercise, that would probably create the only environment in which a real deal could happen without losing your customer base,” Mr. Bane says.

President-elect Barack Obama’s transition team is exploring a swift prepackaged bankruptcy for automakers as a possible solution, Bloomberg News reported Friday.

Others argue there may not be enough time for such a solution given the precarious financial position of the Detroit three.

The more ambitious a prepack is, in terms of renegotiating not just with bondholders, but also with labour unions and other stakeholders, the more complex it becomes, says Jay Swartz, a partner at law firm Davies Ward Phillips & Vineberg, who has been involved in numerous corporate restructurings.

Mr. Swartz says the real issue with a bankruptcy filing by an automaker is the ripple effects it has on the supply base. As soon as a company files for protection, it is not obliged to pay any pre-filing debts. That will threaten the suppliers, who won’t be paid until a reorganization is finished and may have few other customers to offset the lost cash flow, he says.

“If you don’t address that problem in a Chapter 11 or a CCAA, then your entire supply chain is going to get totally disrupted and there’s going to be absolute chaos,” Mr. Swartz says.

Mitt Romney, a Republican whose father ran American Motors Corp., argued in the New York Times this past week that the best way to save Detroit’s automakers is to let them go bankrupt. Larry Kudlow, host of Kudlow & Company on CBNC, said bankruptcy is as American as apple pie.

Bankruptcy always carries with it a little bit of a stigma, says Derrick Tay, a senior partner with Ogilvy Renault in Toronto, who acted in Air Canada’s CCAA filing in 2003. But people generally tend to overestimate its negative impact, he says.

Many companies have been able to work out warranties for their products in bankruptcy. Many have successfully convinced their customers that they will be in business in the long term. “If [the sales argument about nobody buying cars from a company in creditor protection] were true, then no company should ever survive bankruptcy,” Mr. Tay says.

Mr. Tay argues the problem facing the Detroit automakers in particular is not how they will convince people to buy their cars after they have filed for bankruptcy protection.

“The problem is, do people want your cars at all? That’s a problem that filing or not filing is not going to help. And what’s worse, that’s a problem that getting a government bailout is not going to help.”



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