Bankruptcy doesn’t carry the stigma it used to. Companies file for Chapter 11 all the time and emerge fairly sound. Still, if you had to choose between buying a car from a bankrupt company and a nonbankrupt company, which would you pick?
That’s the question looming over the bankruptcy proceedings of Chrysler and GM. And the Obama administration’s public statements over the next several months may help determine the answer.
So far, President Obama has gone out of his way to reassure the public of the car companies’ solvency. “This is not a sign of weakness,” Obama said when Chrysler filed for bankruptcy in April. Announcing GM’s Chapter 11 filing on Monday, he said: “I want to remind everyone that if you are considering buying a GM car during this period of restructuring, your warrantees will be safe and government-backed.”
It may seem odd to have the leader of the free world—especially during a time when the economy faces systemic problems—guaranteeing your car warranty. (Is that the full powertrain warranty? And how much does he think I should pay for that muffler?) But Obama may have no choice. At this point in his presidency, to steal a phrase, what’s good for GM is good for Obama.
Part of the issue is speed: Once a company recovers, the stigma of bankruptcy fades quickly. Think Kmart, or the airlines that seem to go bankrupt every five minutes. If GM follows a similar trajectory, the skittishness shouldn’t last long. “I think six months from now, no one will remember it ever filed,” says Jonathan Hayes, a bankruptcy professor at the University of West Los Angeles School of Law.
On the other hand, few bankruptcies are as high-profile as GM’s. When most companies file for bankruptcy, the news lands on the inside pages of the business section. The woes of GM and Chrysler are regular front-page news. At the same time, cars are different from groceries and plane tickets in that they’re long-term investments—buyers expect to be able to get their cars serviced for years to come. As a result, bankruptcy could hurt consumer confidence in Chrysler and GM more than usual. Guaranteeing warranties helps, but it might not cure the nagging gut feeling that you’re taking a risk buying that Buick.
The key is making sure people know the difference between Chapter 7 and Chapter 11 bankruptcy. The first type is liquidation. Under Chapter 7, an insolvent company sells off all its assets in order to pay back its creditors. When the process is over, the company no longer exists. Chapter 11, meanwhile, is reorganization: It allows companies to revise contracts under court supervision in order to help them get back on their feet. In GM’s case, that means renegotiating wages, cutting back on pension funds, and closing dealerships. (Chapter 13 is for individuals; Chapter 12 is for farmers and fishermen.)
The federal courts don’t keep track of how many companies emerge from Chapter 11 bankruptcy. (There were 10,160 such filings in 2008.) But history suggests that GM has a more-than-decent shot. In general, the larger the company, the better its odds of survival—and GM is ginormous. Plus, few companies get government backing. As part of the bankruptcy filing, Treasury promised $30 billion in financing. The governments of Canada and Ontario are lending $9.5 billion. And the administration appears to be keeping the door open for future aid. Also in GM’s favor is the fact that many companies lower their prices after bankruptcy. That’s one reason Chrysler posted better sales in May than it did in April.
So the odds of GM surviving are good. The question is, do people know that? Or is bankruptcy—whatever the type and whatever its severity—a scarlet letter? “There are still people out there who believe if you’ve ever uttered the word bankruptcy in your life, you should go straight to hell,” says Hayes, the bankruptcy professor. Those consumers “won’t buy a GM car after this.”
GM needs to convince those customers that bankruptcy is merely a step on the way toward becoming a healthier company—and that’s where Obama comes in. In 1979, Chrysler nearly entered bankruptcy but got rescued by federal loans. As part of its recovery plan, CEO Lee Iacocca starred in ads where he personally reassured customers about the company’s solvency. (“If you can find a better car, buy it.”) The company simultaneously offered rebates and deals, and came out reinvigorated.
No one expects Obama to cut spots for GM or Chrysler. But without a spokesman like Iacocca to boost confidence, the car companies are relying on the president. Frequent updates about the companies’ status, statistics on the number of cars being sold, and maybe even a pointed drive in his Chrysler 300C could help stave off the stigma of bankruptcy.
Above all, he may want to tease apart the two types of bankruptcy. Several recent bankruptcies have ended in annihilation, notably Circuit City and Linens ‘n’ Things. But those were Chapter 7. Obama should make sure people understand that GM and Chrysler are different. Or, better yet, he may want to avoid the word bankruptcy entirely. Maybe he can call it GM’s “recovery and reinvestment” plan.