Bankruptcy 101: Personal vs. Corporate
MICHEL MARTIN, host:
I'm Michel Martin and this is TELL ME MORE from NPR News.
Coming up, we'll talk about those programs to forgive student loans. States and the federal government have been using them to draw people to careers in vital but low-paying occupations. But could the recession jeopardize those programs? We'll try to find out in just a few minutes. But first, news from bankruptcy court, where auto giant General Motors found itself yesterday. The embattled company has faced years of losses and market share declined. And while the bankruptcy cost thousands of employees their jobs, today GM is still open for business. But is that the same for individuals who find themselves in a deep financial hole? What's the difference?
Our regular Money Coach Alvin Hall is traveling. So joining us to explore these questions are two people who have joined us before. Michelle Singletary, she's an expert on personal finance and the author of the nationally syndicated column, "The Color of Money." Also with us is Boyce Watkins. He is an assistant professor of finance at Syracuse University and also a commentator and blogger on finance and other issues. Welcome back to you both. Thank you for joining us.
Assistant Professor BOYCE WATKINS (Finance, Syracuse University): Glad to be here.
Ms. MICHELLE SINGLETARY (Columnist, Washington Post): Glad to be here as well.
MARTIN: Boyce Watkins - please explain what happens when a company files for bankruptcy?
Asst. Prof. WATKINS: Bankruptcy is effectively a financial incubator in which the company says, look, hey we can't take it anymore. We don't have the liquidity to meet all of our debt obligations and we're literally suffocating under this debt. So we're going to go to the government for a little bit of protection, just long enough for us to reorganize. And the trade-off though is that the equity holders who are traditionally in control of the company, they get to make the decisions, they get to vote, they get to decide the direction of the company, they're sort of giving a lot of that control over to the government and to trustees who are then assigned the responsibility of making sure that the claims of the debt holders are respected and represented.
And so the ultimate goal is, within bankruptcy, is to hopefully create a safe space in which the company can reorganize itself, re-energize itself and sort of get prepared to take on the world back out in the wild again. The same way you keep the baby in the incubator until he's ready to breathe on his own.
MARTIN: Michelle, what about personal bankruptcy? Do the same principles hold true?
Ms. SINGLETARY: Generally with personal bankruptcy, most people file under either chapter VII or chapter XIII. Very few individuals file under chapter XI, unless the are small business owners. And so, under VII, you're basically saying, I'm broke. I don't have anymore money. I'm sorry. You're not getting paid. And those who do get some money, generally if you've got a house or a car, something that is backed, you have an asset that you can turn in or still hold on to.
Chapter XIII allows people to keep a lot of their things and workout a repayment plan. So what are you saying is, you know, I'm really busted but not broke. So I have some money to pay you back. And I'm going to generally take about, in chapter XIII, three to five years to pay people back most of what you owe. So, it's very different for individuals than it is when a corporation files for chapter XI.
MARTIN: And why is that?
Ms. SINGLETARY: Well, because with individuals, especially if you're talking about chapter VII, you're basically saying, I'm done. I have no more money. I'm not going to be able to pay you. And you get a clean slate of your unsecured debt. So things are wiped away. There are some debts that are not wiped away like tax debts, student loans, those kinds of things. And so that's how it's different.
With the chapter XI with a business they're allowed to continue to operate and they're saying, yeah I'm broke but, you know, I think if you give me some slack I can try to make my way out of this. And there have been major companies that have filed for Chapter XI and have come out of it. Kmart for one. People thought they were dead, but they were able to survive. They're a much leaner company than they used to be but there's still Kmart's around.
And there are major companies that filed Chapter XI who can't come out. They just can't, you know, make enough business to keep themselves going.
MARTIN: But Michelle you have cautioned repeatedly in your column and on this program and other programs about personal bankruptcy as a last resort. Why is it such a dire step or why should it be such a last resort step for individuals?
Ms. SINGLETARY: Well, because for individuals it really does ruin your credit for about 10 years. So that means anytime you going forward, that you want to buy a car or a house or something, it's going to cost you a lot of money. Now the way the system used to work is you really couldn't buy anything for a very long time. Now that's not the case. You can buy something, a car and a house, but you're going to pay, you know, double or triple the interest rates of someone who has good credit. And, you know, there's also the moral application. If you can avoid bankruptcy, if you can cut your budget, get some extra money, do everything you can to try to pay people back, that is the right thing to do.
MARTIN: But Boyce, you know, but this is an interesting question because I don't hear these moral arguments attached to corporations that file for bankruptcy, Boyce. And, you know, I'm not sure why that is because we think of corporations as fundamentally amoral or why?
(Soundbite of laughter)
Asst. Prof. WATKINS: The job of a company's managers is to maximize shareholders wealth. And so, morality only becomes convenient if it's profitable to be moral. So the truth of the matter is that corporations have their own incentives. It's not necessarily morality that might keep them from filing. But you have reputational impacts of filing for bankruptcy. Most Americans don't really understand what bankruptcy means when it comes to a corporation. And they don't understand the benefits of bankruptcy. So when GM says we're going to go bankrupt and Toyota says, hey, we're not going bankrupt. Then, you know, that person deciding which car to buy and which warranty to believe in is going to think, well, may be Toyota is a little bit of a safer bet.
And even though that's not necessarily the case because one of the things that's interesting about GM is that they're getting support from the Obama administration, which is a pretty strong financial backer for right or wrong. So, bankruptcy can actually be a good thing for a corporation. In the case of GM they really need to be restructured because if you really look at the details of GM's balance sheet it's an absolute mess. So I'm curious to see how this is going to turn out.
MARTIN: If you're just joining us, you're listening to TELL ME MORE from NPR News. I'm speaking with personal finance columnist Michelle Singletary and professor of finance, Boyce Watkins. And we're talking about personal and corporate bankruptcy. We're comparing and contrasting. Boyce, you made the point that there are reputational effects for companies as well as for individuals. And a number of people pointed out that - it's, say an airline going into bankruptcy is different than a car company. Say maybe you buy a ticket from an airline and you're going to go on a trip and it's over in a week or whatever. But for a car you're expecting to have it for a number of years.
And so you're worried if - that car company is going to be around to service your car. What about, you know, all the employees who have invested their careers in a company like GM. I mean there are people who worked for GM for decades. There are people who worked for GM over two or three generations. Is it really realistic to expect a company like GM to come out of this okay, to survive and even to thrive?
Asst. Prof. WATKINS: GM can survive. The problem is that they made a lot of commitments during their heyday that have served to cripple them to this day. For example, the job banks where you can get laid off and still get paid every day as if you were working each day. You know, these agreements that have been made throughout the past. If fact, if you look at GM's financial obligations, a huge percentage of their spending goes to people who don't even work for the company anymore.
And so, GM really needs to get to a safe space with the federal government, which I think was a good idea, and renegotiate these terms in a way that hopefully can be fair to the American worker while at the same time allowing this company to be lean enough and strong enough to compete. But then there's a competing argument that says, you know, the government shouldn't even step in to support this company. They should just allow GM to disappear and allow more effective and efficient companies to fill that market share.
And I'm not saying which side of that debate I'm on but I will say that GM certainly has some things that need to be re-negotiated. And the greatest benefit to GM in terms of bankruptcy is that they get to re-negotiate their contracts with their laborers as well as with their creditors, which are a little bit out of whack.
MARTIN: Michelle, how about individuals who declare bankruptcy. As we know there have been a wave of bankruptcies of individuals owing to current economic conditions and I'm sure other factors that you would identify. But what happens next? What can individuals do to repair their financial profiles after a bankruptcy?
Ms. SINGLETARY: Right. Well the thing is there is life after bankruptcy. Many people go on to buy homes and cars and live productive lives. You know, the whole point of bankruptcy is to give you a fresh start. And so the way to begin that is to - now that you don't have all that debt that is oppressive to you, to pay your bills going forward on time. And in a short period of time, less than probably two or three years you'll see your credit rating go up and you'll be able to, you know, go back and do hopefully better with your money. So it's not, you know, it's not like you're in a coffin and that's it. But - but it gives you a fresh start. And for some people that's needed.
Lots of people file bankruptcy, not - you know, there's this thought that people are, you know, racking up all this credit-card debt. For the most part, people who file bankruptcy, a couple things have happened. They've lost their job, they got a divorce, they had a lot of medical expenses. There's a lot of reasons why people file for bankruptcy.
MARTIN: Yeah, serious health conditions, for example. And finally, Michelle, do you think - I'm wondering, given the prevalence of bankruptcy and all the public discussion around it because of the corporate situation, because of the recession, do you think that our cultural concept of bankruptcy will change as a result of the era that we're in? Do you think that - I guess what I'm wondering is do you think there'll be as much stigma attached to it in the future as there has been in the past?
Ms. SINGLETARY: I think it will be. You know, I covered bankruptcy for a very long time for the Washington Post, and I've been in courts with people who filed, and people agonize about this. I'm sure GM still agonized about this. And you should be. You should agonize. So, no, I don't think the stigma will go away.
Those people who I know who filed were wracked with guilt about it, and many of them - there are a small sliver of people who do it, and they're just deadbeats. But for the most part, people who file for bankruptcy, it's their last thing. They just can't handle it anymore. And I think the stigma should stay, because it should be a stop-gap so that people really consider, do I need to do this?
MARTIN: Michelle Singletary is an expert on personal finance. She's the author of the nationally syndicated column, "The Color of Money," along with a number of books. She joined us by phone from her home office in Maryland. Boyce Watkins is an assistant professor of finance at Syracuse University and a well-known commentator and blogger, and he joined us from WAER in Syracuse. I thank you both so much for joining us.
Ms. SINGLETARY: You're welcome.
Professor WATKINS: Thank you for having me.
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