Fixing GM May Just Be Practice for the Next Bailout

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Fred Thornhill/Reuters

General Motors auto workers load the new Chevrolet Camaro for delivery

GM's (GM) stock trades at $1.71, which is not even its 52-week low. Several news outlets have reported that the Treasury has asked the No.1 US car company to prepare for Chapter 11. The government will probably try to have GM broken into two pieces. In that case, most of the creditors may be stuck holding paper in the weaker of the operations which will be made of brands like Saturn and Hummer which have no economic value at all. If that tactic works, the money that GM owes to financial firms could end up being next to nothing.

But, GM may still make it as a public company because a bankruptcy could be too messy for the Administration's tastes. According to The Wall Street Journal, "Key members of an ad hoc committee representing GM bondholders have begun preparing arguments against the auto maker's bankruptcy plan." The creditors may lose their attempt to get a better deal than being given debt in a company which holds the worst part of the GM asset base, but they can make the process prolonged and painful for the company and the Treasury. (See the 50 worst cars of all time.)

Creditors are not the government's biggest problem with GM, although they would like the public to think debt is the headache everyone should focus on. A bankruptcy judge could force a large cut in health and retirement benefits for UAW members. That would be on top of what is likely to be another round of lay-offs. With the national unemployment rate moving up as fast as it is and large numbers of pensions facing funding problems, the federal government may not want to be forced to support current and retired GM workers. Someone will have to pay for the healthcare of the tens of thousands of retired GM employees. Someone will have to pay unemployment for the tens of thousands of auto workers who do not have jobs and have no training to find new ones.

There are several estimates of what a GM bankruptcy would cost in terms of jobs loss, both at the company and suppliers. The figures which are over a million unemployed are probably not accurate. GM has already fired too many people and so have its suppliers. But, an event that pushes even several hundred thousand people out of work would hamper the Administration's efforts to get unemployment under control.

The issues of creditors, employment, and the survival of suppliers are not the real problem behind the government's concerns about the ultimate fate of GM. The real concern is that what happens at the auto company sets a precedent for the next bailout of a large American non-financial company. The government has been able to stay away from completely restructuring banks by providing them with enough capital to work their way through piles of bad assets and tight credit. The process is not over. Major US banks may need tens of billions of dollars more in government assistance when the results of the "stress tests" of bank viability are finalized later this month. The Treasury may tell Bank of America (BAC) that it needs $15 billion in additional capital and the bank may be able to raise that money on the government's deadline. If it can't, it could be merged into another bank the way that Wachovia and Washington Mutual were. The government has avoided getting its hands dirty with the banks. In Detroit it could become deeply involved in the salvage process by taking a major American company though a bankruptcy court with an independent judge sitting on the bench.

The most important reason for the government to expend this great effort on GM and Chrysler is that the car business is such a large employer. There is no longer a case to be made that the auto manufacturing business is "strategic". If the auto industry was ever in a position to enjoy that designation, it was when the American car companies had 70% of the market. At this point, Toyota (TM) and Honda (HMC) could buy the divisions of GM that they believe can be profitable and the domestic auto market would see very little disruption at all.

The industry that has the largest number of employees in the US is not automotive. It is retail. If the economy does not recover quickly, there is a case to be made that one or more large retailers could face problems not unlike those being faced by GM. The largest retailers have two advantages over car companies. For the most part, they do not have crushing debt loads. Secondly, they do not have the legacy labor costs that are a result of UAW negotiations with The Big Three, although some have pension plans that are not completely funded.

What retailers do have is employees, and at this point way too many of them. Dillard's (DDS), which is not one of the largest retailers, lost 19% of its same-store sales last month. The company has 33,000 employees which means that it is not much smaller than Chrysler's US car operation. Rite Aid has 4,900 stores and it is in real trouble. If Rite Aid faced bankruptcy it would cause unemployment problems, but it could also trigger a destructive chain of events in the real estate industry by defaulting on store leases at locations all over the country. Neiman Marcus had a same-store sales loss of 30% last month. The company has $3 billion in long term debt and had paper thin operating margins on $1 billion in revenue last quarter, which was down from over $1.3 billion in the same period the year before. Neiman Marcus also has substantial pension obligations.

Are any of the large retailers in enough trouble to go bankrupt next week? No. But, if unemployment keeps rising and consumer confidence keeps falling, the same thing may not be true next quarter. Several large retailers cannot stay in business for another year if their sales are dropping 25% or more.

A year ago, neither the car companies nor the federal government thought that they would be facing a decision on one or two Chapter 11 filings or how the fall-out from these events would be managed. A year ago, no one expected the GDP to fall as fast as it is falling or that the economy would be losing 600,000 jobs a month.

There are enough clever people in the Administration to know that more very large US companies could fail. How fast that will happen and how many will fail depends on factors from macroeconomic considerations to individual company debt service.

For the government, the auto bankruptcy is not the issue. The issue is how well the process prepares it for the next industry bailout. At this point, GM is just a test case.

Douglas A. McIntyre

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