Bankruptcy Not Bailout (Updated)

This morning Thomas Friedman rails against the domestic auto industry and, as usual, he’s half right:

How could these companies be so bad for so long? Clearly the combination of a very un-innovative business culture, visionless management and overly generous labor contracts explains a lot of it. It led to a situation whereby General Motors could make money only by selling big, gas-guzzling S.U.V.’s and trucks. Therefore, instead of focusing on making money by innovating around fuel efficiency, productivity and design, G.M. threw way too much energy into lobbying and maneuvering to protect its gas guzzlers.

This included striking special deals with Congress that allowed the Detroit automakers to count the mileage of gas guzzlers as being less than they really were — provided they made some cars flex-fuel capable for ethanol. It included special offers of $1.99-a-gallon gasoline for a year to any customer who purchased a gas guzzler. And it included endless lobbying to block Congress from raising the miles-per-gallon requirements. The result was an industry that became brain dead.

There are some other signal failures that Mr. Friedman does not mention, for example, for years the auto companies have been pruning their salaried payroll with buyouts. Buyouts are the coward’s approach to reducing the number of employees. People with desireable skills or entrepeneurial instinct accept buyouts because they’re confident they can get a job as good or better elsewhere. People who are (frequently correctly) convinced they could never get a job as good hang on until the bitter end. This has resulted in the most capable, most desireable, and most needed salaried employees going off to greener pastures while the drones stay behind.

Mr. Friedman continues by quoting Paul Ingrassia:

“In return for any direct government aid,” he wrote, “the board and the management [of G.M.] should go. Shareholders should lose their paltry remaining equity. And a government-appointed receiver — someone hard-nosed and nonpolitical — should have broad power to revamp G.M. with a viable business plan and return it to a private operation as soon as possible. That will mean tearing up existing contracts with unions, dealers and suppliers, closing some operations and selling others and downsizing the company … Giving G.M. a blank check — which the company and the United Auto Workers union badly want, and which Washington will be tempted to grant — would be an enormous mistake.”

While appealing in some ways that’s not the right solution. Top managers have contracts that granted them certain benefits when they leave the company and doing anything about them would be likely to prove tricky, seizing, “just compensation” and all. They’ll leave with their golden parachutes neatly intact stripping the companies of a handy chunk of the capital they need.

I continue to think that Chapter 11 bankruptcy is the appropriate solution to General Motors’s problem in particular. The court’s powers in equity give it the ability to re-write contracts and that will solve a good portion of the company’s problems going forward. Some bring up the problems that a company that sells a large ticket warrantied product will have in retaining its customers in the case of bankruptcy. The essence of entrepeneurialism is the willingness to take risks and I think it’s reasonable to ask the managers and owners of the auto companies to show some of that spirit.

The alternative is for you and I to show that spirit for which I can divine little earthly reason. Note: my thoughts on the employment issue for the automobile industry are here.

Update

Andrew Sullivan weighs in:

Man, I hope Pelosi doesn’t get her way. Tom Friedman’s column made a valiant effort to make the case for a bailout, but I don’t see one. Haven’t I given up enough of my income to incompetent capitalists?

Shouldn’t that be “alleged capitalists”?