This is a bit of a bombshell. The WSJ is out with a report that the Obama administration may well let GM and Chrysler go Chapter ll. In fact, they say that Chrysler isn’t viable absent a merger of some sort with Fiat.

Here is the meat of the report from the Journal.

The administration’s auto team announced the departure of Mr. Wagoner on Sunday. In a summary of its findings, the task force added that it doesn’t believe Chrysler is viable as a stand-alone company, and suggested that the best chance for success for both GM and Chrysler “may well require utilizing the bankruptcy code in a quick and surgical way.”

The move also indicates that the Treasury Department intends to wade more deeply than most observers expected into the affairs of the country’s largest and oldest car company.

After over a month of analysis, the administration’s auto task force determined that neither company had put forward viable plans to restructure and survive. The verdict was gloomier for Chrysler. The government said it would provide Chrysler with capital for 30 days to cut a workable arrangement with Fiat SpA, the Italian auto maker that has a tentative alliance with Chrysler.

If the two reach a definitive alliance agreement, the government would consider investing up to $6 billion more in Chrysler. If the talks fail, the company would be allowed to collapse.

Despite the grim view of Chrysler, the task force said it had no intention of replacing CEO Robert Nardelli. Unlike Mr. Wagoner, who had been at the helm of GM since 2000, Mr. Nardelli is considered an auto-industry outsider who has only been in charge at Chrysler since the company was acquired by Cerberus Capital Management LP in 2007.

In addition to pushing out Mr. Wagoner, the task force said GM is in the process of replacing the majority of its directors. Kent Kresa, a longtime director, will serve as interim chairman. Mr. Wagoner will be replaced as CEO by Chief Operating Officer Frederick “Fritz” Henderson.

The administration said it would provide the company sufficient working capital for 60 more days, during which a revamped GM board and top management has to put forward a much more rigorous restructuring plan than it submitted last month.

“The administration is prepared to stand by GM throughout this process to ensure that GM emerges with a fresh start and a promising future,” according to term sheets released by the White House Monday morning.

Administration officials made it clear that an expedited and heavily supervised bankruptcy reorganization was still very much a possibility for both companies. One official, speaking of GM, compared such a proceeding to a “quick rinse” that could rid the company of much of its debt and contractual obligations.

The clearest losers appear to be the thousands of bondholders and lenders to both GM and Chrysler. In both cases, administration officials said that the companies were burdened by inordinate amounts of debt that would have to be scrubbed. Chrysler’s survival, the administration said, would require “extinguishing the vast majority” of the company’s secured debt and all of its unsecured debt and equity.

Boy, this sure goes against the conventional wisdom floating around the last few days. That had the Obamaites caving to a rescue. That, at first glance, isn’t the case at all. Most interesting is the shot at the bondholders. Are we finally going to see that group of investors take their deserved losses?

Tomorrow is going to be a very interesting day. I suspect that the markets aren’t going to like this much. It appeared as if we were settling into some semblance of if not normalcy at least less of a crisis of the day scenario. This will dispel that notion for a few days. 

To assure consumers reluctant to buy GM or Chrysler cars, the government plans to take the unusual step of guaranteeing all warrantees on new cars from either company. These guarantees would lapse back to the companies once they return to health.