Preventing a GM Trainwreck

New York City - Just when fear seemed to be receding in the economy, and the appearance of green shoots seemed to presage recovery by the end of the year, yesterday, senior GM officials indicated they expect GM to enter bankruptcy come June. June 1 is the deadline set by the government's Auto Task Torce for GM's various creditors, principally the government itself, unions and bondholders to strike a deal that will keep GM in business. However, it now appears a deal will not be forthcoming and GM may shortly follow Chrysler into federal bankruptcy court in New York only without a pre-existing deal structure to expedite the bankruptcy proceeding.

There is still a way to prevent a trainwreck, but only if the parties act quickly.

First consider what bankruptcy would mean.

As I have written before, in contrast to Chrysler whose bankruptcy has proceeded fairly smoothly so far, a GM bankruptcy would be more disruptive to the general economy as well as the people directly involved. Why? GM has 55,000 workers and hundreds of thousands of retirees who still depend on the company for benefits. It also has a far larger network of suppliers than Chrysler. In sales alone, it has historically been more than twice as large as Chrysler.

The greater problem, however, is that GM has a different capital structure than Chrysler's. Whereas a handful of banks and hedge funds owned all of Chrysler's debt and a private company its equity making a deal comparatively easy to structure, GM because of its size and iconic status is owned by a wide universe of people. Its publicly traded stock is, of course, widely held. And it's unsecured bonds--once thought to be rock solid--are held by everyone from pension funds to community banks to individuals.

For this reason working out a settlement with GM bondholders was always likely to be more difficult than with Chrysler, and the consequences of failure greater. Sure enough, the government was able to get most of Chrysler's small group of bondholders to agree to the deal at the center of the pre-packaged bankruptcy now underway. However, so far the government and GM's diverse group of bondholders are barely even talking.

Were GM to enter bankruptcy without a prepackaged deal, the proceedings would be extraordinarily complex. America's bankruptcy procedures--designed to protect investors in private enterprise--are a key asset of our capitalist system that substantially reduce the cost of credit and draw the world's capital to our shores. They pre-date the current financial turmoil and do, in fact, reduce uncertainty by creating an orderly route to unwind business. There is no certainty that a bankruptcy judge, bound to protect the many stakeholders of GM would do what the government requests. While it is tempting to imagine wiping out speculators, in reality, established precedent and law are the best way to insure equity of competing claims.

In turn, every week that a bankruptcy proceeding continues would lessen sales and erode the value of GM's assets, making it more likely that the company would have to liquidate, destroying an important engine of the economy and harming America's prospects for participating in the clean tech revolution just when electric cars are taking off.

Fortunately there may still be a way to cut a deal but time is running out. The latest government proposal calls for unions to trade in health care claims for for 39% of the equity of a reorganized company. And it calls for bondholders to swap $27 billion for about 10% of equity with a requirement that at least 90% of bondholders make the swap to insure remaining debt does not exceed about $2.7 billion.

The unions support the deal: though painful, they judge it better than the
alternative of bankruptcy. But the bondholders--who view their claims as equal to the unions--don't find it better than what they might receive from a judge. Without their buy-in, the outcome may leave workers, bondholders and the country poorer.

Game theorists may recognize the classic collective action problem of the Prisoner's Dilemna where, absent cooperation, everyone ends up worse off.

Recently, however, a proposal has been floated of taking a page from the 1979 Chrysler rescue and offering bond holders who make the swap, not only 10% of equity, but also the $2.7 billion in debt the government has suggested the company could carry--if it has Treasury backed insurance. In lieu of an actual cash redemption by the company, the Treasury guaranty would be far smaller than others recently extended. This proposal could be the basis for a pre-packaged bankruptcy come June.

As the clock ticks down on what may be the largest and most disruptive bankruptcy in global history, this simple idea deserves serious consideration by the parties concerned.