Chapter 11 bankruptcy is one of the greatest glories of American capitalism. It evolved organically during the financial crises of the late 1880s, was replaced with a more punitive code in the 1930s, and then was resurrected and codified in the late 1970s. Chapter 11 allows companies that got in over their heads to seek a way out that allows them to stay alive. It balances forgiveness with punishment. It allows for fresh starts. When it works as intended, it enables the opposite of the sort of zombie capitalism that prevailed in Japan in the 1990s.
That’s not to say it always does work as intended, or is perfectly designed. The practice of jurisdiction-shopping is kinda creepy. And we too often depend on Chapter 11 to deal with messes (our corporate pension system, for example) that could have been more cleanly and fairly resolved by legislation (at least in some parallel universe where the legislating is clean and fair).
But at times like these, when lots and lots of American businesses owe more than they can pay, we should be grateful that we’ve got Chapter 11 and companies aren’t afraid to use it. It’s no coincidence that the two biggest problem areas in the current crisis have been the two industries where Chapter 11 hasn’t been seen as an option: financials and automakers.
In the first case, the problem is that Chapter 11 isn’t up to dealing with a financial panic. It can easily handle the failure of an isolated financial firm in otherwise calm(ish) times—such as Drexel Burnham Lambert in 1990. But when everybody’s trying to get their money out of the financial sector at once, as happened last fall, waiting around for a bankruptcy judge to resolve matters isn’t really an option.
With GM and Chrysler, the arguments against bankruptcy late last year were:
1) due to the financial panic, the debtor-in-possession financing essential to allowing companies to keep operating while in Chapter 11 simply wasn’t available on the scale required by GM in particular
2) fears about warranties and other matters would keep consumers from buying cars made by bankrupt companies.
The government has taken care of #1 by providing the financing, and at least partially addressed #2 by offering to guarantee GM and Chrysler warranties (plus, the companies’ woes have already been dragged through the media so much that it’s hard to imagine a bankruptcy filing would have a significant impact on consumer perceptions at this point).
So now the news comes out that Chrysler may really and truly be headed for bankruptcy court. It could be messy. It could end up really badly for the company. But it is the American way.