How Bankruptcy Would Wreck GM and Chrysler

The economy is so bad in parts of Detroit that a home there recently sold for $1. For the automakers based nearby, it's not looking much better.

Car sales are in a tailspin on account of $4 gas and a swooning economy, and as usual, the Detroit automakers are suffering more than their competitors. Overall, sales are down about 11 percent so far this year, according to J.D. Power & Associates. But at the Detroit 3, sales are down an outsized 18 percent. The biggest reason is an overreliance on big trucks and SUVs and a dearth of small cars that consumers actually like.

Ford has been hit hard, but looks to have enough cash to ride out a worst-case downturn and survive until 2010, when the market should rebound and recent labor cutbacks will start to pay off. But cash-flow problems are more precarious at General Motors and Chrysler, where analysts think a Chapter 11 filing is a serious possibility if the car business stays weak through 2009. To some, that seems like no big deal: Other companies, including four big airlines, auto-supplier Delphi, and retailer Kmart have used bankruptcy to rein in bloat, slash costs, and get healthier.

But for GM or Chrysler, declaring bankruptcy would be more like slashing their own tires. Customers would flee, consumers would be unsympathetic, and the government would probably do little to help. Here's why bankruptcy would be such a dire scenario for any one of the Detroit 3:

Buyers would bail. When airlines like United, Delta, and Northwest declared bankruptcy, most fliers stuck with them. That's because it was clear those airlines would stay in business at least long enough to honor their tickets. But it wouldn't work that way for an automaker. Most people who buy airline tickets plan to use them within weeks. But consumers spend way more on a car than an airline ticket, and commit to the product for years. It's kind of important that the company selling the product be around to make good on a 60,000-mile warranty, service the car, and supply parts.

Simply declaring bankruptcy would be a disaster for an automaker, even if the company seemed likely to ultimately survive. In a survey conducted by CNW Marketing Research, 80 percent of people close to buying a new car said they would abandon an automaker if it were to file for bankruptcy. Not surprisingly, the numbers were higher for the Detroit 3, and lower for most foreign makes. An automaker could forestall the doom somewhat by offering fire sale prices—but selling cars at a loss would only perpetuate underlying profitability problems. "In today's marketplace, bankruptcy for General Motors (or any major automaker) is a death knell," CNW concluded in a recent newsletter.

Bankruptcy wouldn't solve much. For airlines and other big companies that have successfully emerged from bankruptcy, Chapter 11 allowed them to cut costs and other expenses they were unable to address under normal operations. The airlines, for instance, were able to slash pensions and renegotiate rich labor contracts that were signed when the airlines were flush, but which they could no longer afford. That improved cash flow and helped them get back on their feet.

The automakers, by contrast, don't have a major problem funding their pensions. And they've already negotiated deep wage and job cuts with their unions, and cut billions in costs. "They're not being crushed by wage and benefit costs," says Mark Oline of Fitch Ratings. "It's about revenue and products now. It's a business model issue."

Bankruptcy might allow Chrysler or GM to offload some debt—but it wouldn't do anything to increase revenue, speed the arrival of must-have new products like slick compact cars and family-oriented crossovers, or fund technology breakthroughs like GM hopes the Chevy Volt plug-in hybrid will be.

Bankruptcy is such a dire scenario that analysts think GM would first sell off whole divisions, like perhaps Saab or Saturn, in addition to the Hummer franchise it has already put on the block. Chrysler's most valuable assets are the Jeep brand and the Dodge Ram pickup, product lines that could be melded into another automaker. Chrysler, which is now owned by private-equity firm Cerberus Capital, has been a particular curiosity. As a private firm it no longer has to report financial details to the public, and some analysts think it may already be operating close to the brink of insolvency. Oline expects Chrysler to start refuting such speculation with more transparent financial reporting.

A government bailout seems unlikely. At least a big one does. GM and Chrysler combined control just 30 percent of the U.S. market today, a nose dive from the days when the domestics dominated the industry. GM is fending off Toyota for the U.S. sales lead; Chrysler, once one of the "Big 3," is now No. 5 in the United States. And American-built cars from Toyota, Honda, and other "importers" now make up a sizable chunk of overall sales.

Translation: Aside from the Michigan delegation in Congress, there's little government appetite for an automaker bailout. "There's not the mood to do it," says one industry lobbyist. "People feel like the Detroit 3 dug this hole and they've got to get themselves out." A test case will come this fall, in a bill that contains $6 billion in low-interest loans for domestic automakers to retool aging factories. The bill still has to get through Congress, and if it does there's no sign yet whether President Bush will sign it or threaten a veto.

Neither company is too big to fail. When the Federal Reserve rescued a rump Bear Stearns earlier this year, the financial firm was a fraction the size of GM. But regulators feared that if Bear Stearns failed, a daisy chain of called loans, bank runs, and subsequent failures could swamp the entire financial system. The same logic applies to Fannie Mae and Freddie Mac, the huge mortgage funders that underwrite nearly half of all U.S. mortgages and now seem to be approaching insolvency; if one or both collapsed, the collateral damage would be deep and widespread.

That wouldn't happen in the auto industry if GM or Chrysler went down. No doubt there would be more job losses and financial pain, but it would probably be confined to the Rust Belt and other areas where the Detroit 3 were once dominant. As a private company, Chrysler would hardly be in any position to ask for government aid. And if either company did ultimately declare bankruptcy, it would probably happen at a time of deep Bailout Fatigue in Washington.

There's one other unsettling prospect: The market may not even need three domestic automakers. In fact, the quick shrinkage or even disappearance of a big carmaker might solve an oversupply problem: An industry that built and sold almost 17 million vehicles in 2004 and 2005 will be lucky to sell 14 million in 2008. And there's no guarantee that sales will bounce back to levels that many thought amounted to a mini-bubble. That sharp reduction can be spread across all the players—or borne by a few of the most beleaguered. Which is what seems to be happening.