Over the past several weeks, one solution that has been floated to fix GM’s ills is a prepackaged bankruptcy (see Obama Team Said to Explore Prepack). According to Bloomberg:
President-Elect Barack Obama’s transition team is exploring a swift, prepackaged bankruptcy for automakers as a possible solution to the industry’s financial crisis, according to a person familiar with the matter.
In a pre-packaged bankruptcy, interested stakeholders (creditors, unions, shareholders, suppliers, etc.) come together to reach an ex ante agreement on how to share costs and burdens, and how to reorganize operations so as to make the ex post process less disruptive, and less likely to end up in liquidation.
Which brings me to Saturday evening…
On Saturday evening I was having dinner with some friends when the conversation quickly turned to GM. One of those in attendance at the dinner has been in the reorganization, restructuring, and turnaround business for more than 25 years. He has even served as the interim CEO of various large corporations. Another at the dinner was a Managing Director at one of the large (still existing) investment banks.
We agreed on one specific issue: The chances of a pre-packaged bankruptcy for GM are remote. The issue with GM is that the interests of the disparate stakeholders are so far apart that it is hard to envision them reaching any meaningful agreement on how to share the costs associated with the reorganization. In addition, they will likely find it difficult to agree ex ante on what exact steps GM needs to take to right its ship.
For example, the UAW is interested in maximizing wages and employment while creditors are interested in decreasing GM’s cost structure and paring down its lines of business. But even among creditors there are groups with different interests, with those with the greatest rights in favor of moving more quickly to Chapter 11 without any pre-packaged arrangement.
For this reason, I believe that the most likely arrangement is one of the following:
- Aid provided to GM by the government to avert bankruptcy
- Aid provided to GM by the government after it has declared bankruptcy
In the first scenario (aid provided before bankruptcy), the government would provide aid in the form of debt, equity, or both, with the right/intent to use those capital injections to exert influence. This would require the government to sign off on a restructuring plan for GM in advance. In the second scenario (aid provided after bankruptcy), the government acts as the DIP financier of only resort (after all, who in the private sector has the means, or the interest, to provide financing to GM on that scale, and in this credit environment). After providing the DIP financing, the government can then cram a restructuring plan down GM’s throat.
The nice thing about the latter approach is that it allows greater flexibility when it comes to replacing management, renegotiating contracts, shutting dealerships, and streamlining operations. The nice thing about the former is that it provides aid in a context that does not risk the meltdown scenario in which buyers and suppliers refuse to do business with GM, however remote that outcome.
I have detailed why I believe that it is not imprudent to provide aid for GM (see Preventing Moral Hazard and Aid for the Automakers for greater detail). However, I have been adamant that whatever aid the taxpayer provides comes with properly structured terms, with properly structured incentives, and at a hefty price to current shareholders, creditors, and management.
In particular, in the case of GM, conditions for the receipt of aid could include:
- The ousting of current top management
- A moratorium on mergers and acquisitions
- A renegotiation of employment terms with the UAW, …with all options on the table
- The rationalization of brands – for GM my suggestion would be to keep only Chevrolet, Cadillac, Opel, and potentially, Buick (given its standing in the China market)
- A shutdown of all plants tied to brands that GM will no longer manufacture, and a consolidation of the remaining brands into a few, select plants
- Incentives (in the form of tax credits) to produce smaller, more fuel-efficient automobiles
Although these terms seem fairly onerous, such terms (or variants thereof) provide the only reasonable chance left to derive some value from GM.