Friday, November 14, 2008

DIP Financing for the Big Three

As MidMark Capital has a few auto suppliers in its portfolio, I have been intimately involved in various aspects of the current mess in Detroit, and have a few thoughts on how it ought to be handled.

Washington is now mulling over how to handle the crisis, and it has quite a few options. With Washington just having just offered up $750 billion to save the financial industry, there seems to be little popular or legislative support for the same thing again. It seems as if a consensus is growing that the government ought to just let the auto companies go bankrupt and come out the other side smaller, nimbler, more efficient, and making better products.

I generally agree, especially as bankruptcy would allow the court to invalidate prohibitively expensive labor agreements with the UAW. Bankruptcy will not be a panacea, however, and Ron Gettelfinger will still have enormous power in determining what the restructured industry looks like. It may take four of five bankruptcies over the next 50 years in order to finally make the US auto industry competitive in a global marketplace. So, let's get started with the first.

However, there are some very serious issues which need to be worked out before any of these companies can file. First, they will need cash to operate while in bankruptcy. In a normal bankruptcy proceeding, a company will receive DIP (Debtor-in-possession) financing from a bank while in bankruptcy.

But DIP financing for the big auto companies would be simply ginormous. There is no clear indication that it would be available anywhere in the marketplace, especially since we are still in the midst of an unprecedented credit meltdown. Where are these companies going to get DIP financing?

Letting any of the big three go into Chapter 7, or liquidation, would be simply disastrous. Plenty of people have written extensively on this issue, so I won't go into it, except to say that there would be job losses in the millions amongst the Big Three and their suppliers. Ultimately, the cost would make any rescue package today seem like small potatoes.

The obvious answer, to me, is the that U.S. government should step in as the source of DIP financing, and then get out of the way as the auto companies declare bankruptcy. That way, we could be assured that the OEMs would have enough liquidity to operate through bankruptcy, but the private markets could work their magic to shrink the companies and enable them to come out the other side as more robust companies.

One other note: the government should also step in temporarily as guarantor on all of the auto companies' payables to its supply base. If those payables (in the many billions) were to go bad, there would be enough bankruptcies among the supply base to make it seem like the OEMs themselves had gone bankrupt.

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