David Skeel wrote the book on bankruptcy. That is, his Debt’s Dominion explained why American bankruptcy law is the way it is. Bankruptcy is bound to be a big issue in the coming year, with the Tribune Company filing, and with automakers poised to endure a “quasi-bankruptcy,” in Skeel’s words, under the government bailout plan, with bankruptcy still a possibility. We asked Skeel to discuss cars, news, and how the collapse of railroads built the present-day bankruptcy system.

Q: Why does Washington prefer bailout to bankruptcy when it comes to automakers?
A: I think the government’s perception is that if General Motors actually filed for bankruptcy, people would panic, and it would have ripple effects throughout the economy. This great fear has led the government to construct a bankruptcy by other means. I think the fears are exaggerated, though it’s clear that whatever the outcome, it is going to have huge effects on millions of people.

Q: Could automakers actually benefit from filing for bankruptcy, the way some airlines appear to have done?
A: I think car companies could be dealt with on balance with bankruptcy. The government could make the kind of loans they’re making in bankruptcy. Nothing precludes them from doing that. My view is not the view in Washington, obviously.
But people have been making the argument that you don’t worry too much about dealing with a bankrupt airline once your flight is over. You don’t have to worry about whether the airline will be healthy in the future. With a car company, when you buy a car, you have a warranty for several years, so you might be worried about whether the company will be around to satisfy that warranty. So there’s this perception that people wouldn’t be willing to buy cars from companies in bankruptcy. I am not persuaded by that argument.

Q: What defines a “successful” bankruptcy filing?
A: That is sort of a loaded question. There have been several traditional industries where there have been industry-wide crises. The biggies before the carmakers were the airlines and the steel companies…. With the steel companies, what’s happened is we’ve emerged with a very different-looking industry. The assets of some of the traditional steel companies were bought by new and different steel companies with lower labor and manufacturing costs. Some would say that was a good outcome, others would say, well we’ve lost a big chunk of our traditional steel industry. The bankrupt airlines, for the most part, are better off for having been through bankruptcy. They reduced a lot of their costs and a lot of their debt, though I don’t think anyone would say it’s a healthy industry today.

Q: The Tribune Company filed for bankruptcy earlier this month. How do you think their newspapers will fare after filing?
A: One concern with a newspaper company is whether the major newspapers are economically viable…. If the newspaper industry is not viable, or if the Tribune is not viable, there’s not much you can do in bankruptcy to change that. You can reduce the debt, but if the company is making losses month after month, it won’t help. The Tribune also has a very unusual financial structure after the buyout by [Sam] Zell… The really wrenching thing about the bankruptcy is that the whole buyout was done on shareholder employees’ backs. I think that’s going to complicate the bankruptcy. For folks who have a big stake, it’s obviously not a good thing.

Q: As you note in your book, American bankruptcies are unusual in that the managers who filed usually continue to run the company, which may be of concern to some employees. Why is this?
A: That’s the thing that makes American bankruptcy different from almost any other system in the world, even now that many countries have adopted systems like our Chapter 11. What people elsewhere in the world think is why do you want to keep the people who got the company into this trouble running things? It seems like a very strange rule to people outside of the U.S., but there are a couple arguments for it. One is that managers know the business better than anybody else. Another argument might be that since they know the business, they’re in a position to keep the company running as normally as possible.
Another part of the explanation is that if you kick managers out the minute a company files, managers are going to do whatever they can to keep the company from filing for bankruptcy, so they’ll wait too long to file. And if managers have misbehaved, you can replace them in bankruptcy, there is a mechanism for doing that [in the U.S. system].

Q: Was American bankruptcy law ever otherwise, or did managers always stay in charge?
A: It was not in the beginning. The way our corporate reorganization system emerged was in the late 19th century, when the railroad industry collapsed. There was a perception that it would be a mistake to let them just fail. No one would be better off if they stopped operations. There needed to be a way to reorganize, and there wasn’t, so it ended up being done through the courts. That procedure looked a lot like the current Chapter 11, with managers running the companies in bankruptcy. There was a period when that got changed during the New Deal, so that managers got kicked out when a company filed for bankruptcy. That lasted until 1978…. So our bankruptcy system came out of the railroad company failures, which in some respect were industry-wide failures, somewhat analogous to steel and airlines and car companies.

Q: Could you elaborate on that – how were railroads similar to airlines and automakers today?
A: The railroad situation in 19th century and the airline situation in our generation are somewhat similar in that it’s clear we need the industry, but the structure is economically irrational. With railroads, some of the irrationalities were worked out. With the airline industry, I’m not sure where we are. I don’t think anybody has a silver bullet solution as to how to make the airline industry fully economically rational…. Bankruptcy is the social solution of first and last resort when you can’t decide what to do in Washington, so it’s being worked out to some extent.

Q: And what about Detroit? Do we need the Big Three or can we survive with other makers?
A: I personally believe that there is still a role for American cars. There are some that are well made and people want to buy them, but it’s very clear that Detroit needs major restructuring, and one of the core problems is simply that the structure of the auto industry – the relationship between the firm and the employees, and the nature of the union contracts – was hammered out at a time when the world was very different than it is now. It just doesn’t work now. The costs are too high….
A big chunk of my hostility to a bailout of the industry, and my preference for bankruptcy, is that I would much rather have the creditors, including employees, determining at what point the car company becomes viable and how it should be restructured, rather than trying to micromanage that from Washington. But it looks like we’re going to get a lot of micromanaging.

*Photo courtesy Derek Farr.