Jonathan Lipson’s Auto Immune: The Detroit Bailout and the Shadow Bankruptcy System

Dave Hoffman

Dave Hoffman is the Murray Shusterman Professor of Transactional and Business Law at Temple Law School. He specializes in law and psychology, contracts, and quantitative analysis of civil procedure. He currently teaches contracts, civil procedure, corporations, and law and economics.

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4 Responses

  1. TRE says:

    Even assuming everything you say is true, why should “we the people” care if a parade of horribles happens to the big three? Whatever the moral hazard that exists in the bankruptcy system, isn’t there a greater moral hazard is telling big companies that basically they won’t be allowed to fail.

    “Moreover, while it may be true that Detroit’s products are not great, U.S. manufacturers cannot be credibly blamed for their predicament.”

    Really? Perhaps you were not aware but the companies in question have not been in good financial or business shape for years.

  2. Jonathan Lipson says:

    I am well aware of the feeble condition of the automakers. That’s the point of the title: Their financial immune system has been compromised by years of mismanagement, poor products, etc.

    And ordinarily I would agree with you that bailouts of even the limited sort proposed here create moral hazard, among many other problems. But the question is whether those costs exceed the cost of permitting the automakers to truly fail–not just to reorganize in the “orderly” way the administration might have hoped, but to liquidate in some really ugly way, as I suspect would happen? The deadweight losses to the economy would be staggering.

    I continue to believe in the general logic of your observation. But this is not the right case for it. This is why I opposed the Bear Stearns bailout (as I blogged here). I suspected then–and continue to believe–that this caused or at least exacerbated today’s credit crisis. I am sure that a Bear bankruptcy would have been ugly, too. But I believe that would have scared market actors into the hard work of deleveraging through renegotiation that they simply did not do.

    That deleveraging in the end may have saved tax payers hundreds of billions of dollars. It would not have saved the auto industry, of course. But it would have permitted it to continue (without taxpayer assistance) the restructuring process that began last year when the UAW took over legacy benefits costs. Under those circumstances–where credit market actors were doing their work, and not just lining up for the dole–I would say the auto industry should be permitted to sink or swim on its own.

    It’s interesting that the auto industry has taken such a beating in this. Few suggest that the banks and other financial institutions that have received the vast bulk of the TARP money–on apparently looser terms–should have been permitted to fail in the ways you suggest the auto industry should be permitted to die.

    If I were cynical, I would think this was a PR move orchestrated by the financial services sector to divert attention from the fact that TARP is apparently doing little that was promised. I won’t even get into the absurdity of financial services firms paying bonuses with tax money, although it sounds like that’s happening.

    In short, there is plenty of blame to go around. Usually, when a building is burning (or patient is coding) our first questions aren’t about blame. We don’t ask whether it’s better to let the structure collapse or the patient die. Maybe we should, but I am not there yet.

  3. STB says:

    First, I am skeptical of claims that people will stop buying cars because a manufacturer is in Chapter 11.

    * * *

    I am sure bankruptcy would scare off some customers.

    So, it appears that you are saying that, yes, some people will be scared off, but not as many as feared. There is support for this in some recent surveys, but these surveys are not without their detractors, and there are reasonable concerns that consumers will have far different concerns when buying a car than they have when purchasing airline tickets. At best, we have a ten percent decline in the number of customers who will even consider purchasing their cars, and the remaining sales will likely be driven by discounts and other incentives. Lower sales AND lower profits per sale are hardly a recipe for turning around a company that is already bleeding money.

    Regardless of whether you agree with the more conservative polls on the one hand, or the consumer psychologists and industry polls that predict Armageddon in Detroit upon a bankruptcy filing on the other, auto executives and politicians sensibly want to avoid the risk at this stage. This bailout makes sense on this front because it buys time to (a) make consumers more comfortable with the possibility of a bankrupt automaker (discussed in the first link) and (b) work with creditors/other constituencies, even if these discussions ultimately lead to a bankruptcy filing (esp. if we see a controlled sale filing along the lines of what we saw in some of the steel companies).

    The second argument—about lost jobs—is doubtless true, but likely exaggerated.

    Perhaps, though I find it odd that your discussion focuses only on direct employment at these automakers, which accounts for less than ten percent of the job losses the C.A.R. projects over the next two years. The stronger criticism of the job loss argument is that this approach does not appear to save very many jobs in the long run. Anyone who believes this package will be the final salvation for the auto industry, and a large block of jobs will thus be saved, is in for a rude awakening.

  4. Jonathan Lipson says:

    I agree with your last point. Perhaps I wasn’t clear, but this is what I was trying to get at when I said: “Moreover, many of these jobs and benefits already have been lost or reduced. Indeed, if you look at what has happened (and is continuing to happen), a slow-motion, herky-jerky form of “workout” is already taking place.”

    The discussion of the UAW’s concessions wasn’t meant to be exclusive. An earlier version had a whole section about what I call “bankruptcy cascades”–the dominoing down (and perhaps back up) the production chain likely to follow in the wake of an automaker bankruptcy. This would make the gamesmanship that concerns me that much more complex (and perhaps attrative to the gamers). I excised it becauase I thought it was already too damn long (although I appreciate your reading as far as you did).

    Bottom line: This is all going to be very ugly, for many people. While I am not generally a pessimist (a skeptic maybe, but generally pretty optimistic), there seems to be a growing consensus it’s going to get worse–perhaps a lot worse–before it gets better. The auto industry certainly won’t be immune from that, even if it’s able to avoid chapter 11.