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The Lessons of the GM Bankruptcy

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The Lessons of the GM Bankruptcy

Everybody knew it was ridiculous and unsustainable to pay UAW workers not to work.


Today is the first anniversary of one of this country's less-than-crowning milestones: the bankruptcy of General Motors, once the largest and richest company in the country, and indeed the world.

Keeping GM alive, albeit in shrunken form, was an expensive undertaking for America's taxpayers: about $65 billion in all, if one counts government aid to the company's former financial arm, formerly GMAC, now renamed Ally Bank. For all that money we, as a country, should take away some lessons from the experience. The following get my vote for the three most important:

• Problems denied and solutions delayed will result in a painful and costly day of reckoning.

• In corporate governance, the right people count more than the right structure.

• Appearances can be deceiving.

All three might sound blindingly obvious, but it's amazing how frequently they're ignored. That's especially true for the first lesson, about denial and delay.

Everybody knew it was ridiculous and unsustainable to pay workers indefinitely not to work (in the United Auto Workers union's Jobs Bank), to keep brands such as Saturn and Saab that hardly ever made money, and to pay gold-plated pension and health-care benefits to employees. But all of these practices, paid for by mounting debt obligations, continued for decades in GM's 30-year, slow-motion crash.

Yet there were plenty of warnings. A dramatic one came in a January 2006 speech by auto-industry veteran Jerome B. York, who represented the company's largest individual shareholder at the time, Kirk Kerkorian. Unless GM undertook drastic reforms "the unthinkable could happen" within 1,000 days, predicted York (who died recently). As things turned out he was a mere 30 days off.

The relevant question looking forward is whether the unthinkable—going broke—also could happen to America.

Everybody knows that we're running unsustainable federal deficits. And that Fannie Mae and Freddie Mac created financial sinkholes by helping lenders make mortgages to people who couldn't afford them. And that many states' public-employee pensions funds are hopelessly underfunded for the level of benefits they provide. And that shoveling more money into the public schools without insisting on structural reforms and accountability hasn't produced results and won't do so in the future.

Addressing these issues inevitably means enforcing spending discipline and standing up to public-employee unions in a way that GM failed to do with the UAW. Continued denial and delay will prove ruinous. To put it another way: America bailed out General Motors, but who will bail out America?

The second lesson is almost as important as the first, even though the term "corporate governance" sounds about as exciting as, well, dental floss. But good governance is critical because it is private enterprise that creates capital and funds government (though few people in Washington seem to recognize this). What happened at GM, in contrast to its crosstown rival Ford, is instructive.

On paper General Motors was a model of good corporate governance, while Ford was (and is) a disaster. The Ford family's super-voting Class B shares give it 40% of the votes with less than 4% of the shareholder equity. Class B shares get about 31 votes for every share of the Class A stock that nonfamily members own. And the Ford family gets veto power over any corporate merger or dissolution.

This structure seems to fly in the face of what is generally understood to be sound principles of good corporate governance. Such "undemocratic" provisions are sure to be lamented this month at two major corporate-governance conferences: the ODX (Outstanding Directors Exchange) in New York, and the annual confab at the Millstein Center for Corporate Governance at Yale.

But the Ford board of directors and family came together in 2006 to seek a new CEO from outside the struggling company, even though that meant family scion Bill Ford Jr. had to relinquish command. He volunteered to do so and remains chairman, but not CEO. Meanwhile, the GM board, consisting of blue-chip outside directors who chose a "lead director" from their ranks, steadfastly backed an ineffective management from one disaster to another and wrung its collective hands while the company ran out of cash. Some GM retirees dubbed the directors the "board of bystanders."

Ford's governance might be undemocratic. But at least it concentrates decision-making power in the hands of a few people with a significant emotional and financial stake in the company, and they proved willing to act. Absolutely no one on the General Motors board had either such stake, which helps explain why the directors did nothing.

GM's current board—appointed by the company's controlling shareholder, the U.S. government—has a handful of holdovers from the prior board. Maybe they aren't bad people, but they surely showed judgment that was beyond bad. As the new GM prepares for an initial public offering of stock—so that the government can recoup the taxpayer investment—it will need credibility at the board level. The holdover directors should resign.

As for appearances versus facts, the GM bailout—along with the similar exercise at Chrysler—offers ample evidence. The understandable objection to bailouts is that they foster moral hazard, the willingness to act recklessly without fear of consequences. Yet the bailouts of these two companies had painful consequences aplenty for the major actors.

Shareholders of both companies got wiped out. Creditors took major hits, including those who held secured debt at Chrysler. (Their loans to the company were reckless, the equivalent of subprime mortgage loans, but they did recover more than they would have in a Chrysler liquidation.) Many workers and executives lost their jobs. Many dealers lost franchises. The Jobs Bank was abolished, albeit belatedly. So was no-cost health insurance.

All this seems plenty of pain to discourage future moral hazard. Letting the companies liquidate would have produced far more pain, of course, but much of it would have fallen on innocent bystanders—the ordinary citizens who participate in an economy that was on its knees last spring. The Obama administration, to its credit, tried to walk a fine line: doing enough for Detroit to protect the economy, but not doing so much to foster future irresponsible behavior.

Nobody on any point of America's political spectrum really liked this bailout. But having paid for it, let's hope that we as a nation are willing to learn from it.



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