An Interview With George Mason University Law Professor and Bankruptcy Expert Todd Zywicki (11:37)
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Hoekstra: “What’s your take on the General Motors situation?”
Zywicki: “General Motors is in many ways much more complicated than Chrysler. The big difference between the two cases with respect to prospects for reorganization is that in Chrysler, the main issue involves secure creditors who have the rights to Chrysler’s property, and secondly a general perception that Chrysler is not salvageable as an ongoing entity — stand-alone entity. In General Motors, those two key facts are different. First, you don’t have secure creditors. What you have are a lot of unsecured bondholders, and so whereas in Chrysler the secure creditors were ahead of the unfunded pension plan liabilities, in General Motors, they’re of equal priority. So the question in General Motors is a different one from Chrysler, which is not, ‘Can you take from a senior creditor and give to a junior creditor?’ but, ‘Can you treat two unsecured creditors differently?’ That’s what the issue is on the table in General Motors, and in general, courts have more flexibility to do that.
“The second obvious difference is that General Motors is much more obviously a prospect for a stand-alone Chapter 11 reorganization. Unlike Chrysler, [where] it’s not clear whether they’d be viable as a stand-alone entity, General Motors is clearly going to reorganize. Perhaps they’re going to sell some of their divisions and downsize, but there will still be a General Motors at the end of the day.”
Hoekstra: “How messy is it going to be, though?”
Zywicki: “It will be messy, that’s for sure. It’s such a complex, sprawling company. What they obviously are contemplating is closing a lot of dealers, as is the case in Chrysler, and selling some of their product line — getting rid of them, or selling them or whatever the case may be.
“The other wild card of course is government regulation on things like fuel economy standards and all those sorts of things. … One of the benefits to Chrysler is in some sense [if] they sell to Fiat, they get out from under all that government regulation that basically forces them to make bad business decisions and make cars that consumers don’t want. Whereas General Motors will still have that baggage associated with it, so that whether General Motors can cut its cost structure and remain viable going forward is still an open question if they still have their hands tied on actually making cars that people want.”
Hoekstra: “You’ve been calling for bankruptcy — I know for General Motors, at the very least — since late last year. Is it 'too little, too late' for these companies?”
Zywicki: “It would have been better if it had come earlier, and one of the big reasons is what we’re seeing in Chrysler, which if it had come earlier, we wouldn’t have the problem we have now with the government meddling. … In Chrysler, there is a lot of criticism of the way the government has gotten their hands in this case, and in fact, it’s not just that in Chrysler that the unfunded pension plans are fleecing the secure creditors: Government itself is claiming an 8 percent equity stake, and they are the very bottom of the barrel there. But they are writing themselves right into that plan, and they are the ones making a lot of these business decisions, it is made very clear here.
“So I think both Chrysler and General Motors would have been better off had they filed for bankruptcy earlier rather than taking that TARP money, because that TARP money comes with so many strings. In the end, bankruptcy’s where they needed to be in order to rationalize their dealer structure, in order to rationalize their labor costs and make the kind of belt-tightening and strategic decisions they needed to make. It was inevitable that they needed to file bankruptcy — better late than never, but better earlier than late.”
Hoekstra: “Now, what about — I’m going to play devil’s advocate just for a second — what about people who are so angry with the automakers for getting into such a situation in the first place, who may say, ‘You know what? I’m glad the government is stepping in.’ Tell us what is so wrong with having the government, as you said, ‘meddling.’”
Zywicki: “Well, there’s a basic question we ask of bankruptcy, which is whether a company is what we call economically failed or in financial distress. So think about the example of Smith Corona typewriters, right? Say Smith Corona filed bankruptcy. Would we reorganize Smith Corona? No, clearly not, right? Because from the perspective of the economy, it’s better off to take a company like Smith Corona and basically liquidate it and sell off its assets: redeploy the financial capital; redeploy the human capital, all the workers and the managers; and redeploy the physical capital, the factories and that sort of thing.
“If you take, by contrast, a company like General Motors, what you have with General Motors is clearly a company that’s not economically failed: It’s just in financial distress. And what bankruptcy is about is making that determination, which is determining whether companies should continue to operate or not, and then taking companies that should continue to operate and fixing their business structure, their assets and liabilities, so that they can be productive going forward. That’s what it’s about — creating economic value. Everything else is just a side show … And so once you put politics in the mix, you don’t know whether or not a company’s worth more alive than dead. You don’t know at that point whether it’s Smith Corona or General Motors that’s in the question.”
Hoekstra: “How dangerous of a precedent is this for the government to be getting involved in these bankruptcies?”
Zywicki: “It’s an unbelievably dangerous precedent, and there were just reports today that some of the hedge funds who got rolled over in the Chrysler case are already saying that they’re going to be much less likely to fund businesses that have politically powerful interests attached to them or unionized workers and that sort of thing. So businesses that may be struggling, who have powerful union workforces, for instance, are going to find that from now on, credit is going to cost them more. It’s more risky to lend to those companies.
“The government also is calling on hedge funds and those sorts of organizations … to deal with all the bank toxic assets, and if you’re one of those hedge funds, you’re going to be much more reluctant to participate in that program if you know that the government can change the rules on you at any time. So I think that by taking this step of making a short-term political calculation to intervene on behalf of political supporters, the administration may have engaged in really counterproductive activity in terms of helping to fix the economy and helping to deal with the larger credit and financial crises.”
Hoekstra: “So for the folks who are watching this who are in the position to influence policy and make decisions either in the business end or on the legislative end, what would you say to them right now?”
Zywicki: “What I would say to them is that going back to the founding of the Constitution, what we understand is that you have to protect the integrity of contracts and property rights if people are going to invest, if people are going to lend money and if people are going to take risks. What we saw was under the Articles of Federation, which predated the Constitution, state legislatures were always meddling in contracts and trying to rewrite contracts to benefit borrowers at the expense of lenders. And the Founders said, ‘That’s not going to work’ — that people are not going to lend money. It’s going to increase the cost of capital if you do that. So that there’s always a temptation for elected officials to try to step in and take the property rights of some people and give them to others.
“In the long run, what we’ve seen — and perhaps even in the short run — [is] that turns out to be counterproductive. And the reason we have a constitution is to limit that temptation. The reason we have bankruptcy laws that establish well-established practices [is] to limit that temptation for politicians to act in a short-term way, to plunder politically unpopular groups to reward economically popular groups. And that’s just a recipe for economic catastrophe.”
Hoekstra: “And economic catastrophe: How long before we see that? And is there any light at the end of the tunnel for us?"
Zywicki: “Well, it’s not going to help if they keep throwing property rights up in the air and intervening in these bankruptcy cases. One can only hope that Chrysler and General Motors are just a one-time exception, and that after that, we’re going to go back to our regularized processes. But if they decide that this is a template for going forward, what you’re going to see is more and more people becoming less and less willing to invest. … You’re going to see more and more pension funds losing money for their own retirees and becoming less and less willing to invest. Once you take steps down violating the rule of law and infringing on contracts and property rights, it’s very hard to reverse that.”