Bankruptcy isnít bad

24 December 2008

Let us imagine that you are a great admirer of the Plattsburgh State Art Museum. Let us imagine that the Museum is in grave financial straits and that the University is planning to close it. You would be unlikely to be concerned that some new purchaser will make a big pile of the artworks and incinerate them. That would be crazy. It is possible, if the collection were bought by a museum elsewhere in the country that the collection would be lost to Plattsburgh. If it were bought by a private collector, it could be lost to public view. But it would not be lost altogether. The art would continue to exist.

This is what happens when an organization is bankrupt. Its assets are sold to the highest bidder and the money used to pay down as much debt as is possible. People buy the assets because they believe they can make better use of them than the existing owners. Bankruptcy redeploys assets from people who are making poor use of them to people who can do better. If this is what Barack Obama meant when he wanted to ďspread the wealth aroundĒ then he was spot on.

When the Soviet Union collapsed it was hard to establish a functioning economy because there was no bankruptcy law. Japan turned a recession in its banking industry into a 10-year depression because banks which were technically bankrupt continued to trade. Bankruptcy is good.

So why, then, are auto-makers so scared of bankruptcy? They argue that if they file for bankruptcy Ė even for the limited bankruptcy of Chapter 11 Ė then no-one will buy cars. There is this risk. A car is a major purchase, and a warranty guaranteed by a bankrupt company is valueless. The talk is, however, overblown. There is no risk that purchasers of a GM, Chrysler or Ford car would be unable to get parts. There are enormous fleets of these cars on the road, and supplying them with parts can be a profitable business. If Detroitís Big Three cannot supply this market profitably it is because they are incompetent. Someone else could, and bankruptcy would give them the chance to do so.

And what, then, is the alternative? That the government should loan them money? That this is not a solution to the problem is just plain math. Bankruptcy is when your assets donít cover your debts. You canít borrow your way out of bankruptcy. Why would you have more confidence in buying a car from a company that has the same assets and larger debts than it did yesterday? Either way, you would be rightly concerned about the value of your warranty.

Chapter 11 is a procedure which allows a company to settle its debts and keep trading. It pays creditors what they would have got by holding a fire sale of the assets, but lets the company keep trading. It sounds like a good idea, but it isnít. It prevents the assets from being redeployed from the bad management to a new, better, management. If GM wants to keep trading its management can compete in an auction for its assets and get them only if they are the high bidder. Chapter 11 is a way of protecting company bosses, not shareholders or creditors. It is better to face facts. These companies are bankrupt. Letís start again.

First published in the Common Sense series for Lake Champlain Weekly

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