Chapter 11 Is the Right Road for US Carmakers

By Joseph Stiglitz, The Financial Times. Posted December 13, 2008.

The debate about whether or not to bail out the Big Three carmakers has been mischaracterised. It has been described as a package to help the undeserving dinosaurs of Detroit. In fact, a plan to bail out the carmakers would benefit shareholders and bondholders as much as anybody else. These are not the people that need help right now. In fact they contributed to the problem.

Financial markets are supposed to allocate capital and monitor that it is used to good effect. They are supposed to be rewarded when they do that job well, but bear the consequences when they fail. The markets failed. Wall Street's focus on quarterly returns encouraged the short-sighted behaviour that contributed to their own demise and that of America's manufacturing, including the automotive industry. Today, they are asking to escape accountability. We should not allow it.

What needs to be done is to help the automakers get a fresh start and allow them to focus on producing good cars rather than trying to juggle their books to meet past obligations.

The US car industry will not be shut down, but it does need to be restructured. That is what Chapter 11 of America's bankruptcy code is supposed to do. A variant of pre-packaged bankruptcy - where all the terms are set before going before the bankruptcy court - can allow them to produce better and more environmentally sound cars. It can also address legacy retiree obligations. The companies may need additional finance. Given the state of financial markets, the US government may have to provide that at terms that give the taxpayers a full return to compensate them for the risk. Government guarantees can provide assurances, as they did two decades ago when Chrysler faced its crisis.

With financial restructuring, the real assets do not disappear. Equity investors (who failed to fulfil their responsibility of oversight) lose everything; bondholders get converted into equity owners and may lose substantial amounts. Freed of the obligation to pay interest, the carmakers will be in a better position. Taxpayer dollars will go far further. Moral hazard - the undermining of incentives - will be averted: a strong message will be sent.

Some will talk of the pension funds and others that will suffer. Yes, but that is true of every investment that has diminished. The government may need to help some pension funds but it is better to do so directly, than via massive bail-outs hoping that a little of the money trickles down to the "widows and orphans". Some will say that bankruptcy will undermine confidence in America's cars. It is the cars and carmakers themselves - and the dismal performance of their executives - that have undermined confidence. With industry experts saying $125bn (94bn, 84bn) or more will be needed, with bail-out fatigue setting in, why should US consumers believe that a $15bn gift will do the trick of a turnround?

It is more plausible that confidence will be restored if the industry is freed of the burden of interest payments and is given a fresh start. Modern cars are complex technological products and the US has demonstrated its strength in advanced technology. US workers, working for Japanese carmakers, have shown their hard work can produce cars that are desirable. America's managers too have demonstrated their managerial skills in many other areas.

The failure lies with the managers of US carmakers and America's financial markets, which failed in their oversight and encouraged short-sighted behaviour. The "bridge loan to nowhere" - the down payment on what could be a sinkhole of enormous proportions - is another example of the short-sighted behaviour that got us into this mess.

As the bailouts continue, numbers that once looked huge are starting to seem almost normal. Hundreds of billons are being given to banks and insurance companies. AIG got $150bn. Compared with that $34bn, or even $125bn, for the automotive industry seems a modest request. Even so, we should not forget that a few months ago, President George W. Bush said there was not enough money for health insurance for poor children although it cost just a few billion dollars.

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Joseph Stiglitz was awarded the Nobel prize in economics in 2001. His latest book is the Three Trillion Dollar War,co-authored with Linda Bilmes (2008).

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