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Insurance Against an Even Bigger Wreck

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By Steven Pearlstein
Saturday, December 20, 2008

At any other time, the day that the federal government stepped in to rescue the domestic auto industry would be a turning point in the history of American capitalism. The only reason it is not is that it was immediately preceded by similar rescues of Bear Stearns, Fannie and Freddie, AIG, and Citigroup. It was just another day in Bailout Nation.

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Let's be clear on one point, however: The story here is not that Americans have lost their stomach for the kind of "creative destruction" that is generated by open and competitive markets, which sometimes results in the big companies going under and thousands of jobs being lost. We never particularly relished it -- who would? -- but we tolerated it in the past, we are still tolerating it now (Circuit City, Lehman Brothers), and we will undoubtedly tolerate it in the future. Moreover, even when the government steps in to rescue these companies, it invariably involves a serious and painful restructuring that results in the loss of thousands and even tens of thousands of jobs. That's not how you define bailout in French.

The real story here is that our economy has been so weakened by a financial crisis brought on by decades of national profligacy and misallocation of capital that the failure of certain companies threatens to turn a bad recession into a serious depression.

Do we know that for certain? Of course not. But what we do know is that it is a genuine risk, with very bad consequences for virtually every American if it happens, and therefore something we need to insure ourselves against. The premium is steep, but it is still a lot less than what a depression would cost. And the only insurer willing to offer the policy is the U.S. Treasury.

Put another way, this isn't a change in policy or principles so much as a temporary change in circumstances. It is to our credit -- and that of the free-marketeers in the Bush administration -- that we have decided to honor another great American tradition and put practicality ahead of rigid ideology.

It is also important to be honest about what's going on here, which is nothing less than a bankruptcy restructuring without the bankruptcy filing. Over the next 90 days, General Motors and Chrysler will meet with their unions and committees of their major unsecured creditors to negotiate how much each of them is going to give up so that viable companies can emerge.

During that time, the government has agreed to provide what in bankruptcy is called debtor-in-possession financing -- a bridge loan to keep the companies going while the restructuring is negotiated. The hope is that at the end of the 90 days, a deal is reached among all the parties and it is possible to make it legally binding on all the stakeholders without resorting to the extraordinary powers of the bankruptcy court. If that is not possible, then the negotiated plan will be run quickly through the bankruptcy process as a "pre-packaged" reorganization.

Since October, it's been obvious that this is the way the story has to end. Unfortunately, everyone was too busy posturing in the hope of delaying the pain and gaining a bit of negotiating advantage. The companies denied that they were running out of money. The union said it had made all the concessions it was going to make. The Michigan congressional delegation kept up the fiction about a "bridge loan" to get the companies through their temporary "liquidity" shortage. Southern Republicans harbored dreams of breaking the United Auto Workers union. And the White House couldn't get past worrying over which pot of money the auto loans came from, as if it made any difference.

If they'd all simply faced reality two months ago, it would have saved us a lot of unnecessary drama.

When all is said and done, the restructuring deal will get done not because anyone will be happy with the result but because it will be better than the alternative -- a messy bankruptcy or liquidation -- for all of the parties. Tens of thousands of jobs will be cut, longtime workers will get pay cuts at year's end, retirees won't get the full health-care coverage they were counting on, hundreds of dealers will be forced to close their doors and creditors will get only a third of their money back. For all of them, including the taxpayers, the consolation prize is that they will own a piece of Chrysler and GM. The government is likely to wind up with about 20 percent of the shares, the union about 25 percent, the unsecured creditors just under half, with maybe 5 percent for dealers. Current shareholders will be lucky if they wind up with the remaining 5 percent.

The whining coming from the UAW that somehow its members are being singled out for sacrifice is absurd. As creditors (through their retiree health plan), they would be treated better than other unsecured creditors under the framework suggested by the White House. Their other complaint -- that they will be forced to work for market-rate wages and benefits, without an ironclad guarantee of job security -- probably won't elicit much sympathy from other taxpayers who have lower wages, no better job security and just lent $17 billion to keep the companies from going under.

Nor should the union harbor fantasies that a newly installed Obama administration will protect their wages and benefits to the detriment of all the other parties. For the past several weeks, the White House has been working quietly and collaboratively with the Obama team, and, as the president-elect suggested in his remarks yesterday, there probably isn't much daylight between them. My guess is that the White House, with Obama encouragement, set conditions that were sufficiently tough and sufficiently flexible that Obama will have room to make modest concessions to his union friends and still come out with a credible plan for making the companies viable again.

Steven Pearlstein can be reached at pearlsteins@washpost.com.


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