Bankruptcy Is the Perfect Remedy

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While Washington tries to arrange a bailout, the Detroit Three auto makers and their union, the United Auto Workers, keep insisting that bankruptcy would be the kiss of death. Not so: a Chapter 11 bankruptcy filing will likely result in a stronger domestic industry.

To understand why, consider that the fundamental question to ask of any firm facing bankruptcy is whether it is "economically failed" or simply "financially failed."

If a typewriter manufacturer were to file for bankruptcy today it likely would be considered an economically failed enterprise. The market for typewriters is small and shrinking, and the manufacturer's financial, physical and human capital would probably be better redeployed elsewhere, such as making computers.

A financially failed enterprise, on the other hand, is worth more alive than dead. Chapter 11 exists to allow it to continue in business while reorganizing. Reorganization arose in the late 19th century when creditors of railroads unable to meet their debt obligations threatened to tear up their tracks, melt them down, and sell the steel as scrap. But innovative judges, lawyers and businessmen recognized that creditors would collect more if they all agreed to reduce their claims and keep the railroads running and producing revenues to pay them off. The same logic animates Chapter 11 today.

Read the full article at The Wall Street Journal

Date published: Dec 16, 2008

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