Why a GM Bankruptcy Would Be a Disaster

Obama isn't just ruling on the fate of a single company. A GM bankruptcy could devastate the very economy he is attempting to stabilize

By William J. Holstein

President Obama is nearing the most important decision a President has made in modern times regarding the American economy. On or about June 1, he will push General Motors (GM), the nation's largest industrial company, into bankruptcy. The key trigger may be on May 26, when GM's offer to bondholders to accept 10¢ on the dollar fails to win acceptance from 90% of them, a criterion that Obama has set for continued loans to GM.

But there's a strong probability the decision to push GM into bankruptcy will be disastrous. The mere threat of bankruptcy caused GM's U.S. sales to fall by 50% in the first quarter from already depressed levels. If GM were to declare Chapter 11 bankruptcy, sales would decline even further.

The reality—which the investment bankers and bankruptcy lawyers guiding Obama don't seem to understand—is that the auto industry is unique in the way it is built on long-term confidence. Buying a vehicle is second only to home buying as the most important financial decision people make, and Americans want to know that the company making their vehicle will exist for at least five more years, that their dealer will continue in business, that their auto loan won't be summarily revoked, and that parts and servicing will be available. That is a fundamentally different psychology from when a consumer buys a ticket from a bankrupt airline or purchases electronics or clothing from a bankrupt retailer. In those instances, there is an expectation of onetime or short-term use.

Suppliers Hanging by Fingernails

Then there are the thousands of suppliers, organized in multiple tiers, that support GM. This system depends on a vast, delicately balanced series of contracts and long-term relationships. Many of these suppliers are already hanging by their fingernails. The longer the uncertainty of bankruptcy lasts, the more likely they are to delay making crucial parts and the more likely it is that some will simply go out of business. In cases where alternate suppliers are not available, GM's assembly lines could start experiencing difficulty or even be forced to shut down.

The risk of liquidation would then loom large because the financial losses would mount. The dislocation would cascade through the economy, not just the Midwest. GM, with its suppliers, represents a full 1% of the economy. It is the largest private-sector purchaser of information technology, so Silicon Valley will feel it; and Madison Avenue will feel the collapse of its advertising spend. Any hopes that the U.S. economy has stabilized would take a beating—there would be another sickening lurch downward. Obama isn't just ruling on the fate of a single company; he is about to pull the trigger on a wide swath of the same economy he is attempting to stabilize.

The Obama camp seems to believe that the Chrysler bankruptcy is a template for what it wants to achieve at GM, but that's a critical mistake. Chrysler was a shell of a company, having been stripped of engineering and design talent by Daimler (DAI) and then mismanaged by private equity owner Cerberus Capital Management. The arrangement is to give the United Auto Workers 55% of Chrysler's shares and to give management control to Italy's Fiat (FIA.MI) group. This may work in political terms, but it's not a real-world business arrangement. The supposedly rescued Chrysler is, in fact, a house of cards that almost certainly will come tumbling down.

GM, in contrast, has invested heavily in product development and new technologies, such as the lithium ion battery for the Chevrolet Volt. It was in the late stages of a transformation effort when the U.S. economy collapsed last fall.

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