Two types of failure

The Volokh Conspiracy's Todd Zywicki explains why General Motors is the kind of case for which Chapter 11 bankruptcy protection was developed:

The fundamental question for any bankrupt business is whether the business is economically failed or financially failed.

Economically Failed: If the business is economically failed, then this means that the current deployment of assets to that company is economically inefficient--i.e., the opportunity cost of using the assets in this manner is less than their current deployment. For instance, if a typewriter manufacturer were to file bankruptcy today, it is likely that the firm would be economically failed. There is a limited market for typewriters and it is shrinking. The financial, physical, and human capital dedicated to typewriter manufacturing would probably be better redeployed to other places in the economy, such as to making computers.

Financially Failed: A financially failed firm is one where the value of the current asset deployment still exceeds the opportunity cost of the assets, but the firm is temporarily unable to generate sufficient revenue to cover its costs. This might be either because revenues are too low or costs are too high. For instance, when Texaco got tagged with a gigantic liability judgment by Pennzoil, Texaco was basically a healthy enterprise with one gigantic liability to deal with. When Boston Market filed bankruptcy, it used bankruptcy to close unprofitable stores (it basically expanded too fast)--there the liabilities were the contingent liabilities of landlord claims associated with closing the stores. When the Pittsburgh Penguins filed bankruptcy, there the idea was both to deal with certain liabilities (Mario Lemieux's unproductive contract) and also to try to generate more revenues by renegotiating bad contracts for sale of concessions, etc.

[...]

GM is a classic example of a firm that looks like a financially failed rather than economically failed. We have both physical capital and human capital with high firm and industry-specific value, namely factories and uniniozed work forces, which value would be lost if those assets were redeployed. It also has at least some going-concern value in its goodwill and namebrands.

What GM needs to do is shed labor contracts, retirement contracts, and modernize its distribution systems by closing many dealerships. It appears to need new management as well. Bankruptcy gives them the opportunity to do all that.

So GM will almost certainly reorganize, as will the other car companies. GM does not look like an economically-failed typewriter manufacturer at this point, but rather a financially-failed company that needs to reorganize and go forward.

(Zywicki writes that he wouldn't necessarily oppose federal aid for the General, but only if the company is reorganized under bankruptcy protection.)

Even if GM fails, that won't mean the end of Chevrolet or Cadillac (or, in China, Buick). These nameplates, and some of the company's more efficient and modern factories, would almost certainly be taken over by another automaker. If Chrysler collapses, you can be sure some other company will start making Jeeps, too. (Dodge, which just introduced a promising new pickup, might also survive in some form. Sadly, I think the Chrysler marque is done for.)

Damian P.

Update: what about Ford? Dearborn is making the most reliable cars coming out of Detroit right now (according to the last Consumer Reports auto issue, anyway) and management is working to bring the company's excellent European-market models to America. Unlike GM and Chrysler, I think Ford might be able to stave off bankruptcy.

If the company does falter, the Ford nameplate will survive, as will the Mustang and the F-150 pickup. Mercury is toast, and Lincoln is a toss-up.

Posted by damian at November 21, 2008 07:51 AM