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March 2002 • Vol 2, No. 3 •

Why Kmart Filed for Chapter 11
The Largest Retail Bankruptcy in US History

By Martin Schreader

No more waiting in long lines!

Like a snowball rolling down a hill, gaining speed and size, the collapse of Enron is deepening the current economic crisis.

Kmart, the country’s second-largest retailer, filed for Chapter 11 bankruptcy January 22. An American economic and cultural landmark for 40 years, the company is now the largest retail bankruptcy in U.S. history (and the sixth largest bankruptcy overall), with $16.3 billion in assets.

At the time of filing for bankruptcy, Kmart had $10.2 billion in debt. The company’s largest creditors include: Bank of New York, $2.37 billion; BankBoston, $119 million; Chase II, $117 million; and BankOne, $66 million.

Kmart opened in 1899 as the S.S. Kresge Company, a five-and-dime store that catered to the working class population of Detroit. In 1962, Kmart was launched as a discount department store. The company, prior to filing for bankruptcy, operated 2,114 stores in all 50 states, Puerto Rico, Guam and the U.S. Virgin Islands, employing about 275,000 workers.

It is now expected that as many as 700 Kmart stores will be closed, with up to one-third of those employed by Kmart losing their jobs. As part of its bankruptcy reorganization, the company plans to cut $600 million in costs through these store closings and layoffs.

The cost of this reorganization and retrenchment for working people will be great. In Detroit, where Kmart is headquartered, thousands work for this company. Many of them have a spouse, parent or other family member who has been laid off by the Big 3 in the last year. The prospect of store closings and mass layoffs by Kmart means that many of these families will lose their only remaining source of income.

Across the country, especially in smaller communities, Kmart stores are often the only major retail store—and a major employer—in the area. Closure of these stores, and the layoffs that will follow will devastate hundreds of small towns and counties.

“I lost everything I had,” said Rita Sassin, a cashier at the Roseville, Mich., Kmart. “After 20 years, it’s gone.” Sassin had just been told that, as a result of Kmart’s filing for bankruptcy, her hours would be reduced and her benefits cut. 

Big ripples in a shrinking pond

The consequences of the bankruptcy will ripple throughout the entire country, not failing to touch any part of the economy. Those most immediately affected will be the many suppliers and vendors that service Kmart. Their outstanding bills will be frozen and remain unpaid until, or if, the company emerges from bankruptcy protection. And, if Kmart does survive bankruptcy, their vendors will only receive a portion of the money owed.

Many suppliers and vendors have already warned that they too are facing bankruptcy because of the frozen accounts and loss of cash flow. According to one economic researcher, “the lives of thousands of people [which, for him, means the lives of thousands of bosses and middlemen] and companies are going to hang in the balance.”

Another key sector of the economy that will take a beating as a result of Kmart’s bankruptcy will be the real estate industry. The decision to close 350—stores with a possible addition of another 350—will, according to the Wall Street Journal, “further rattle a retail real estate sector already absorbing a spate of major bankruptcies and liquidations last year.”

The Journal cited the bankruptcies of Montgomery Ward & Co. and Bradlees, both of whom closed a combined 350 stores, and furniture seller Heilig-Meyers Co., which closed 800 stores when it liquidated in 2001. The construction industry will suffer a one-two punch from the slump in the retail real estate market and the collapse of the surety bond market (see below).

In addition, the effects of the bankruptcy will plague companies that are connected to Kmart by a thousand gossamer threads—primarily through banks and other credit institutions—for years to come. There is likelihood that companies across the country with no direct connection to Kmart will themselves face bankruptcy and liquidation.

When Enron hit the fan, Kmart was caught in the wind

By all rights, this bankruptcy should not have happened. “Kmart’s balance sheet is stronger than it was six years ago, its debt-to-equity ratio is on par with other home-goods retailers, it carries more unique brand names than it used to, and it’s paying vendors faster than most of its competitors.” (Crain’s Detroit Business, January 24, 2002)

In plain language, Kmart’s debt was not large enough to keep it from getting additional credit, thus avoiding bankruptcy. But, as an analyst at the New York Times put it, everything “would have been fine—until Enron scared every last living person in finance out of their wits.”

Or, as the Detroit News and Free Press put it, Enron’s collapse was a key part of Kmart’s “perfect storm.”

Kmart’s slide into bankruptcy began on Jan. 2, when an analyst from Prudential Securities “shocked the business world” (in the sage words of the Wall Street Journal) by saying the company could consider bankruptcy if their problems and the recession failed to improve in the next six months. This sent Kmart’s stock plummeting, losing 17 percent that day.

The company had already been suffering from slow sales during the holiday season, slipping 1 percent from last year. To make matters worse, Kmart also announced it was going to seek additional financing to improve its position. This resulted in Kmart’s credit rating dropping like a stone. Standard & Poor’s lowered their credit rating and removed the company from its index of 500 leading stocks. Then Moody’s Investor Service lowered Kmart’s debt bonds to “junk” status.

Within two weeks, Kmart stock lost almost 90 percent of its value. The company’s market capitalization dropped from $2.7 billion on December 31, 2001, to $900 million on the day Kmart filed for bankruptcy—a loss of two-thirds of its value.

As a result of Kmart’s credit rating being lowered, insurance companies holding the company’s surety bonds demanded immediate payment. Observers believe the insurance companies demanded up to $600 million in cash to cover Kmart’s bonds, right at the time when the company was struggling to pay its suppliers after the holidays.

It is here where the link between the collapse of Enron and Kmart’s bankruptcy emerges. Both companies used surety bonds as a combination of credit and insurance.

According to the Insurance Information Institute, a surety bond is a guarantee to one party that the contractor will perform specified acts, usually within a stated period of time. Contractors are often required to purchase surety bonds if they are working on public projects. The surety company becomes responsible if the contractor defaults. (Detroit News and Free Press, Jan. 27, 2002)

Enron used surety bonds as a means of guaranteeing the performance of the energy contracts it bought and sold, and as a way to secure relations with its vendors. Kmart, on the other hand, used these bonds to support its workers’ compensation program and to cover its liabilities coming from sales of guns and liquor.

When Enron went bankrupt, the contracts they made with vendors, suppliers and customers went unfulfilled. The surety bond insurance companies were left to pay for the shortfall. It is estimated that these costs will exceed $2.5 billion—more than 75 percent of a year’s premiums for this type of bond. It was this massive default that prompted the surety companies to demand Kmart pay up, which they had to do with the cash set aside to pay their vendors.

On Jan. 21, one of Kmart’s most important vendors suspended shipments to the retailer, causing new concerns. Fleming Cos., which supplies Kmart with most of its food and paper products, refused to send more merchandise until Kmart paid its $76-million grocery debt. The next day, Kmart filed for court protection. (ibid.)

The role of credit under capitalism

Enron’s use of surety bonds as both insurance and credit was part of that company’s “bizarre accounting practices.” While surety bonds are considered an “obscure form of insurance” (and a rather shaky form of credit), they provide an excellent window for examining the role of credit and insurance under capitalism.

“So much of the retail business relies on credit,” said Mike Porter, stock analyst for Morningstar in Chicago. “If suppliers started looking around at Enron—another Standard & Poor’s company that shut down within weeks—then they heard the report about a possible Kmart bankruptcy, they probably started to tighten up on terms, asking for more cash.”

Credit and the credit system play a double role under capitalism. A well-defined and elaborate credit system, on the one hand, requires the concentration of the means of production—everything from factories to stores—in the hands of a few people, the capitalists. It is this monopoly on the means of production, this concentration and centralization of wealth in the hands of the capitalists, that allows for the extension of credit. This concentration and centralization of capital has been accomplished through the fusion of industrial capitalism with banking capitalism (which is why four banks are the largest creditors of Kmart).

The centralization of capital also transforms its character. When the individual capitalist combines with others—for example, through agreements with banks—their individual capital becomes transformed into a social capital. The average profit of the individual capitalist ceases to be determined by the degree of exploitation that he or she can extract from the workers directly under their employ.

Instead, the average profit becomes dependent on the quantity of surplus labor (the degree of exploitation) appropriated by the total combination of capitalists. It is from this central pool of exploitation that the individual capitalist receives his or her dividend; and this is only proportional to the amount of capital originally brought into the agreement. This social character of capital is promoted and fully realized through the full development of the credit system.

On the other hand, credit pushes production beyond its limits. Credit places all available capital (including capital that is not being used) at the disposal of the capitalists. This allows them to grow and expand to a greater degree than they could if they decided to “go it alone.” After a while, the use of credit erases the lines of individual ownership; neither the lenders nor users of credit are its real owners or producers. Thus it does away with any remains of the private, individual character of capital—ultimately foreshadowing the elimination of capitalism itself.

Or, as Marx put it:

The credit system appears as the main lever of over-production and over-speculation in commerce solely because the reproduction process, which is elastic by nature, is here forced to its extreme limits, and is so forced because a large part of the social capital is employed by people who do not own it and who consequently tackle things quite differently than the owner, who anxiously weighs the limitations of his private capital in so far as he handles it himself. This simply demonstrates the fact that the self-expansion of capital based on the contradictory nature of capitalist production permits an actual free development only up to a certain point, so that in fact it constitutes an immanent fetter and barrier to production, which are continually broken through by the credit system.
Hence, the credit system accelerates the material development of the productive forces and the establishment of the world-market. It is the historical mission of the capitalist system of production to raise these material foundations of the new mode of production to a certain degree of perfection. At the same time credit accelerates the violent eruptions of this contradiction—crises—and thereby the elements of disintegration of the old mode of production.
The two characteristics immanent in the credit system are, on the one hand, to develop the incentive of capitalist production, enrichment through exploitation of the labor of others, to the purest and most colossal form of gambling and swindling, and to reduce more and more the number of the few who exploit the social wealth; on the other hand, to constitute the form of transition to a new mode of production. (K. Marx, Capital, Vol. 3, Ch. XXVII, New World [New York], p. 441)

It is time to end capitalist anarchy!

In spite of the fact that the quarter of a million workers who are employed by Kmart had nothing to do with the collapse of Enron, the gutting of the surety bond market or the filing of bankruptcy, they will bear the cost of these decisions. This reflects two central building blocks of capitalism: anarchy of production and intensified exploitation.

In a rationally planned economy, where production is designed for meeting the needs of people and not the greed of Wall Street, the anarchic and chaotic methods of credit and speculation that gave birth to and fed Enron—and Kmart—would not exist. The con game played by all capitalist companies with the credit system, whether it’s called “bizarre accounting practices” or “bankruptcy protection,” would not exist. It would not need to exist.

As for exploitation, that can be seen by the sweet deals given to the heads of Kmart as a “reward” for taking the company into bankruptcy. The new chairman of Kmart’s board, James Adamson, will be paid $4.5 million, with an additional $4 million bonus, if the company emerges from bankruptcy next year, a figure that even analysts have called “extraordinary.”

CEO Chuck Conaway sealed a deal with Kmart’s board of directors the night before the corporation filed for bankruptcy where he will receive at least $11.5 million, whether or not the company survives bankruptcy. The board also agreed to forgive a $5 million loan to Conaway made last year, as long as he stays with Kmart through July 31, 2003, or even if he is fired “without cause” before then.

The bankruptcy filing also stipulates that Kmart will forgive loans, in the amount of $2.5 million, to each of several lower level executives if they remain with the company through Jan. 31, 2004, or if they are fired without cause. This includes at least four executive vice presidents.

Meanwhile, thousands of Kmart workers—cashiers, stockers, drivers, etc.—and their family and friends will be thrown out on the streets, with little or no hope of finding the kind of living standard they once had.

The bankruptcy of Kmart is a reflection of the bankruptcy of capitalism as a system. As long as capitalism exists, the threat of mass unemployment, hunger, poverty and exploitation hangs over the heads of the working class. It is socialist revolution, carried out by those very same workers, which will forever eliminate that threat from human society.





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