UPDATE: Chrysler Files For Bankruptcy As Creditor Talks Fail

Iconic U.S. auto maker Chrysler LLC on Thursday filed for bankruptcy protection at the behest of the U.S. government after failing to reach an agreement with a small group of creditors.

Italy's Fiat SpA (FIATY), as part of the process, will take a small stake in Chrysler initially but could eventually take control of the U.S. auto maker.

The administration, which led the crisis talks because it is providing essential cash to the car company, expects a quick bankruptcy proceeding to be wrapped up in as little as 30 to 60 days.

"This process will be quick, it will be efficient," said U.S. President Barack Obama in a television address.

The government, which has already provided billions of dollars to Chrysler, said Thursday it would commit a further $8 billion to help the company through bankruptcy.

Market reaction to the troubles of such a major company were subdued, as this possible outcome had been well signaled since the end of March, when President Obama set a May 1 deadline for Chrysler to strike tough deals with creditors and employees. Big banks had already substantially written down their Chrysler debt and won't have to take drastic remedial action, which also soothed investors.

Stock markets were steady, with the Dow Jones Industrials Average unchanged on the day at around 8198 points, but the auto stocks including those of Ford Motor Co. (F) and General Motors Corp. (GM) surged, as the orderly bankruptcy process brightened the outlook for the industry.

A bankruptcy court in the Southern District of New York will handle the restructuring plan, which could be easier to push through because, unlike the out-of-court talks, it doesn't need approval of all parties. Large creditors, including U.S. banks JPMorgan Chase & Co. (JPM), Citigroup Inc. (C), Morgan Stanley (MS) and Goldman Sachs Group Inc. (GS), had supported the government's proposal to give lenders $2 billion in cash for the forgiveness of $6.9 billion in loans.

During his noon address, President Obama took a tough stance against what he described as the small group of "speculators" which had held up the Chrysler restructuring. The bankruptcy proceedings are "designed to deal with those last few holdouts," Obama said.

The holdouts, largely hedge funds, said in a statement released Wednesday before the president's address that they questioned the administration's willingness to negotiate, saying their own offer was "flatly rejected or ignored."

If the court plan is approved, Chrysler's car-making operations would be sold to a new company, which would emerge from bankruptcy under entirely new ownership and without onerous obligations to creditors and employees.

The existing shareholders, Cerberus Capital Management LP and Daimler AG (DAI), would lose all their holdings, and a health-care trust fund for retirees, the Voluntary Employee Benefit Association, would emerge as the new majority owner, with a 55% stake.

Fiat on Thursday agreed to a partnership with Chrysler, under which it will initially receive a 20% stake in the U.S. company. That stake could rise to 35% if certain targets are met; the Italian company also has an option to become a majority stakeholder once the U.S. loans have been repaid.

The U.S. Treasury Department, meanwhile, will own 8% of Chrysler, and the governments of Canada and Ontario, which will provide $2.4 billion in financing, will hold a combined 2% stake.

The company's 54,000 employees and its 115,000 retirees, represented by the United Auto Workers' union, late Wednesday approved their part of the bargain, eliminating a number of benefits.

While the court plan is being worked out, Chrysler said most manufacturing operations will be suspended Monday and will resume once the transaction is completed. Further layoffs aren't expected at this point, although, once the agreement with Fiat goes through, more cost-cutting measures may be needed.

Chrysler said its operations in Mexico and Canada and other international operations aren't part of any bankruptcy filing.

Shortly after the president's speech, Chrysler Chief Executive Bob Nardelli said he would resign, returning to work for Cerberus, which had appointed him to run the company in August 2007.

As part of the deal, GMAC Financial Services, GM's financing arm, will provide financing for Chrysler dealers and customers.

The U.S. government tried to head off accusations that it is meddling too deeply in the economy, and in the auto industry in particular, by stressing its role as an investor, rather than as a manager.

"The government has a major investment in this company and it is overseeing its investment," said a senior administration official. "The company is being run by its management team and it will continue to be run by its management team."

Once the dust has settled, the administration will "try to look ahead and plan for the government's eventual exit as an equity holder," the official said.

-By Matthew Cowley, Dow Jones Newswires; 201 938 5692; [e-mail]