Chrysler LLC will file for bankruptcy on Thursday after talks to restructure its debt with lenders broke down, U.S. President Barack Obama said on Thursday.

Despite intense negotiations over the past few weeks, Chrysler failed to gain the full support from its lenders to avoid the first-ever bankruptcy filing by a major U.S. automaker.

At the same time, Chrysler as expected entered into an alliance with Italian automaker Fiat SpA where it sold a stake starting at 20 percent and in which Fiat can become the majority owner once the government loans are repaid.

The Chapter 11 filing, in U.S. Bankruptcy Court in Manhattan, will send shock waves through the entire industry -- including Chrysler's rivals, suppliers, dealers and the hundreds of thousands who rely on the industry for their livelihoods.

As part of the filing, the U.S. government will provide up to $3.5 billion in debtor-in-possession (DIP) financing and up to $4.5 billion in exit financing. Obama said he hopes the entire bankruptcy process will take only 30 to 60 days.

The bankruptcy signals that Obama is prepared to play hardball with holdout lenders rather than knuckle under to their demands and will likely set the tone for similar discussions with bondholders of General Motors Corp -- which is now on the clock to restructure its operations by the end of May.

This is not the first major government action with Chrysler. In 1980, U.S. President Jimmy Carter signed a bill providing Chrysler with more than $1 billion in loan guarantees.

Once again, the state of Michigan -- and in particular the Detroit area -- will be disproportionately hurt by the auto industry's woes.

The industry's current crisis, with the potential for bankruptcy or consolidation, represents a fundamental shift in the state's economic base, rather than a simple cyclical downturn, Moody's credit ratings agency said in a report last week.

Bankruptcy is what they have been headed for in the past several months, said Mirko Mikelic, portfolio manager at Fifth Third Bank. The biggest concern now is that the different stakeholders will be able to make the tough decisions they need to make.

Investors reacted positively to the news as the broad Standard & Poor's 500 index was up 1.5 percent. GM shares were up 4.4 percent and Ford Motor Co was up 9.2 percent in midday trading on the New York Stock Exchange.

FIAT: A DONE DEAL

The bankruptcy filing did not preclude the Fiat deal.

Chrysler has been seeking a rescue deal from the Italian automaker while also trying to finalize its debt agreement.

The debt restructuring talks have been spearheaded by the Obama administration's autos task force and former investment banker Steve Rattner.

In a bid to win over three fund firms that had spurned an offer to accept $2 billion in cash in exchange for writing off all of Chrysler's $6.9 billion in secured debt, U.S. officials sweetened the terms by throwing in another $250 million, people familiar with those discussions said.

In an earlier memo to employees obtained by Reuters, Chrysler Chief Executive Robert Nardelli had said reaching an agreement with lenders was the company's main focus.

Chrysler, majority-owned by Cerberus Capital Group, has been among the car industry's laggards, but its plight reflects a slump in demand facing an industry whose $2.6 trillion annual revenue is equivalent to the GDP of France and which employs more than 9 million people.

HISTORY-MAKING

The bankruptcy marks a key moment for the automaker and for the struggling American manufacturing sector.

In 1925, Walter P. Chrysler established Chrysler Corp. Three years later, the company laid the cornerstone for the Chrysler Building, briefly the world's tallest building and still an unmistakable part of the Manhattan skyline.

On Wednesday, Obama said concessions by Chrysler's unions and its major bank lenders had made him more hopeful than a month ago that the struggling automaker could be made viable.

The automaker has won cost-cutting concessions from its unions in the United States and Canada and was on the brink of closing its deal with Fiat on Wednesday, a person involved in those negotiations told Reuters.

Putting the two car producers together should give the combined group annual sales of some 4.16 million vehicles, making it equal with Hyundai and behind Toyota, General Motors, Volkswagen and Ford.

(Reporting by Poornima Gupta and John Crawley, additional reporting by Kevin Krolicki, Soyoung Kim, David Bailey, Nick Carey, Jui Chakravorty, Jeff Mason and Giselda Vagnoni; writing by Jo Winterbottom and Patrick Fitzgibbons; Editing by Matthew Lewis)

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