"Good afternoon, and welcome to NPR's 'Car Talk'. Today, we have special guest Douglas Baird of the University of Chicago Law School, here to talk with us about the bankruptcy law implications of the recent crisis in the American automotive industry. Glad to have you with us, professor."
"Good to be here."
"Could you start be explaining the roots of the problem?"
"Well, it's very simple, actually. The domestic automobile industry is tooled for a different technological era and a different car-selling era. The American car market may well be saturated -- there are already more cars in the country than there are people with drivers licenses, and with technological improvements in automobile production, cars have to be replaced less frequently. The result is that the automobile industry has seen sales drop from a consistent 15 million/year, to less than 10 million. But production capacity is still tooled for the prior era, leading to tremendous fixed costs that aren't going to be recouped in the foreseeable future."
"So how do we get rid of that excess capacity?"
"Kill Chrysler. It sounds bloodless but it's true. Some capacity had to be shut down, and Chrysler is not only the least valuable and efficient of the big three, but everyone recognized that it had no real prospects for recovery or renewal. The only question was whether it should be shut down immediately, or gradually to allow some of its functions (and perhaps its few profitable brands, like Jeep), to be taken over by Fiat. For a variety of reasons, the government chose the latter approach."
"That brings up an interesting issue. I know many of our listeners are concerned with the procedures of the bankruptcy sale. How did it work?"
"The federal government persuaded Fiat to create a new subsidiary which would buy Chrysler. It put out a $2 billion bid, which was the only bid made and worth more than Chrysler would be worth if it was entirely liquidated -- or so an expert said. The sale was made, and Chrysler's secured creditors were paid roughly thirty cents on the dollar."
"And with that, we have our first caller. Zach Lynch, from Wykagyl, New York, you're on the air."
"Yes, Professor, I was a secured creditor for Chrysler, so under bankruptcy law I thought I was supposed to get absolute priority over all other creditors. Yet I read that various general creditors, like retiree pension funds, made out like bandits from the sale, while I only got my 30 cents. What gives?"
"Well, Zach, you're right that NewCorp -- Fiat's subsidiary -- did pay money from the sale to various general creditors. But that's immaterial from the perspective of bankruptcy law, because NewCorp wasn't the one in bankruptcy -- Chrysler was. Once NewCorp has obtained Chrysler's assets, it is free to do whatever it wants with them, even seemingly irrational acts like giving them away to groups who were Chrysler's general creditors."
"That sounds very contrived."
"Not at all. Imagine that Chrysler's only asset was a Monet painting, and there were two bids: one for $1 million, and one for $2 million. The latter bid should be accepted, even if the bidder plans to give the Monet away to his mother, even if his mother was also a general creditor of Chrysler. Indeed, you should count yourself lucky: the bidder (NewCorp, here), was willing to pay more than anybody else for Chrysler's assets -- more than Chrysler would be worth liquidated (if the expert is to be believed). Had their bid not gone through, you would have received even less."
"Josie Trumpeter, Germantown, Maryland, you're on."
"Yes, I'm more concerned about the bankruptcy judge's refusal to entertain liquidating bids. If Chrysler was failing, shouldn't it simply be destroyed, to pave the way for better, more creative corporations?"
"Well, that is a concern, but it matters less than you might think. Secured creditors are always free to effectively liquidate a company if there is no bidder who will pay them back in full and they think it would be in their best interest to do so. They can just take out a loan for the amount they're owed and bid that amount at the bankruptcy auction. If they win, the rule of absolute priority means they'll get that money back immediately (which they then have to repay to the bank), giving them control of the debtors assets with no money out of pocket. If they fail to do so, it is presumably because they don't believe that liquidation will actually net them more money than the opposing, lower bid would."
"But I heard that the real reason the creditors didn't make a bid was that they were bribed with TARP money to butt out."
"Bribed is a pretty strong word. What actually happened was that the consortium of secured creditors agreed to appoint an administrative agent to follow the majority will in deciding whether to make a credit bid. Over 90% of the creditors voted in favor of taking NewCorp's $2 billion bid instead. It's true that the dissident remainder claimed that the majority was influenced by TARP money. But so what? These are all big kids -- they knew what they were getting into when they entered into an agreement. Nobody demands that contractual partners have mutually aligned interests in perpetuity. Here, there was an interest-divergence, and some creditors got hosed. It happens. Next time, they can write a clearer contract if they're worried about such things."
"Well, that's all the time we have today. Join us next week when we diagnose radiator problems in a Saab for the last time ever. Until then, this is NPR's 'Car Talk', wishing all car companies safe travels and a healthy holiday season."