All Bankruptcies Are Not Created Equal

US President Barack Obama  (R) and Republican presidential candidate Mitt Romney (L) participate in  the second presidential
US President Barack Obama (R) and Republican presidential candidate Mitt Romney (L) participate in the second presidential debate, the only held in a townhall format, at the David Mack Center at Hofstra University in Hempstead, New York, October 16, 2012, moderated by CNN's Candy Crowley. AFP PHOTO / Stan HONDA (Photo credit should read STAN HONDA/AFP/Getty Images)

Throughout this campaign, and again during Tuesday's Presidential debate, President Obama has reminded voters that Mitt Romney did not support the Obama administration's bailout of General Motors and Chrysler, and that Romney would have instead "let Detroit go bankrupt."

On Tuesday night, Romney fought back, explaining that Obama's auto bailout actually required GM and Chrysler to file for bankruptcy. Romney's intent with this line of attack was clear -- to portray his plan and Obama's as actually having been quite similar, thereby casting doubt on the picture Obama has painted on the campaign trail of one candidate who saved Detroit and another who would have left it for dead.

Who are we to believe? Though technically correct (GM and Chrysler did, in fact, file for bankruptcy protection), Romney's comment overlooks critical differences between how the two candidates proposed to address GM's and Chrysler's impending financial collapse. Regardless of your view on who got it right, it is unquestionable that the candidates would have steered GM and Chrysler down dramatically different paths.

Under Obama's plan, the federal government provided GM and Chrysler with billions of dollars in loans, both before and after the companies filed for bankruptcy. These loans offered GM and Chrysler lifelines to continue their operations outside of bankruptcy while they developed restructuring proposals that could garner the support of the companies' primary stakeholders, including their diverse creditors, unionized employees and retirees. After months of arduous negotiations outside of bankruptcy, GM and Chrysler each commenced what bankruptcy lawyers call a "pre-negotiated" bankruptcy, which means the companies entered bankruptcy with pre-wired restructuring proposals that their key stakeholders largely supported. By doing so, GM and Chrysler were able to chart a remarkably quick, far more certain and ultimately successful emergence from bankruptcy, thereby saving many jobs and preserving going-concern value in the process.

Romney was a vocal critic of the auto bailout, and most notably of the billions of dollars that the government loaned GM and Chrysler in the months preceding their bankruptcy filings. Implicit in his critique, however, is the belief that the restructurings of GM and Chrysler would have been just as successful (or more so) had the companies immediately filed for bankruptcy and only thereafter commenced negotiations with their stakeholders. This is known as a "free-fall" bankruptcy, and while many large and systematically important companies have successfully emerged and prospered after such bankruptcies (for example, most of our domestic airlines), many have also cratered, as such bankruptcies are generally recognized to be far more lengthy and costly, with an outcome that is far less certain. Indeed, no bankruptcy professional would counsel a free fall bankruptcy when an equally effective pre-negotiated bankruptcy is achievable.

However, even if a free-fall was, for whatever reason, Romney's preferred prescription, the vital question his proposal left unanswered was who, if not the federal government, would have financed these free-fall bankruptcies? The Obama administration believed that its loans to GM and Chrysler, especially the loans made before they filed for bankruptcy, were necessary to permit the companies to continue operations while they negotiated with their stakeholders. Neither GM nor Chrysler, the administration concluded, could access the capital markets, both because of their own financial weakness as well as the collapse of financial markets around them in the wake of Lehman's demise. The government, in short, was a true lender of last resort.

And this last point is the nuance that is lost among the campaign barbs. When Obama says that Romney would have "let Detroit go bankrupt," he isn't simply referring to Romney's view that GM and Chrysler should have reorganized their businesses under bankruptcy protection. Indeed, Obama's bailout required the companies to similarly do just that. Rather, Obama is expressing his belief that neither GM nor Chrysler could have privately financed a free-fall bankruptcy filing in 2009, and therefore Romney's proposal, as a practical matter, would have ultimately forced the companies to cease operations, shutter their factories and lay off thousands of workers (not to mention hundreds of thousands of other employees at auto suppliers and other companies whose livelihoods were dependent on GM's and Chrysler's survival).

Of course, it is difficult to prove a negative, and therefore we likely will never know whether Romney's privately-financed free-fall bankruptcies would have achieved a similar (or better) result than Obama's government-sponsored pre-negotiated bankruptcies. But what should be clear is that, debate sound bites notwithstanding, the candidates offered dramatically different views on how to solve the automotive industry's financial woes; they both just happened to include the word "bankruptcy."