Today’s page 1 story in the Wall Street Journal is entitled “GM Seeks $16.6 Billion More in U.S. Aid”. After reading the article, I was mostly surprised and disturbed by Rick Wagoner’s claim that “bankruptcy scenarios are ‘risky’ and ‘costly,’ and would only be pursued as a last resort” (Mr. Wagoner is GM’s chairman and chief executive officer). While it is certainly plausible that GM and Chrysler would need $100 billion and $24 billion respectively in order to go through the Chapter 11 bankruptcy, it seems like false accounting to me for these companies’ top executive officers to argue that bankruptcy would be more expensive for the U.S. taxpayer than bailout loans. This is a very self-serving argument which is motivated more by enlightened self-interest than concern for the public good.
If these companies were to go through Chapter 11 bankruptcy, there is no question that they would need so-called “Debtor-in-possession or DIP financing“. Given their impaired credit statuses, both companies would find it difficult, if not impossible, to obtain DIP financing from private investors. However, it does not therefore follow that the U.S. taxpayer should have to fund these loans. A better (and far less expensive) strategy for the government to follow would be to simply provide DIP financing guarantees to private investors. These investors would have compelling incentives to closely monitor the bankruptcy processes for both firms so as to maximize the likelihood that they emerge from Chapter 11 bankruptcy protection as viable organizations. Although insurance is never “free”, the ex ante cost of a contingent guarantee backstop for the DIP financing would be substantially less than the cost of a bailout loan, and such a strategy would have a far better chance (due to better incentives for monitoring by investors and for the companies themselves to work out sensible deals with their various stakeholders) at producing the policy outcome that the government wants; i.e., a viable U. S. automobile industry.