Streetwise Professor

May 1, 2009

So Much for “Secured”

Filed under: Economics,Financial crisis,Politics — The Professor @ 1:11 pm

The Obama administration–and President Obama personally–have inserted themselves where they do not belong, in the midst of the Chrysler bankruptcy. Obama and his administration have clearly engaged in strongarming secured creditors in order to serve the interest of an unsecured creditor, the UAW, which just happens to be the Democrat Party’s Siamese twin:

Chrysler LLC filed for Chapter 11 bankruptcy protection in New York on Thursday, saying that it would sell its core assets including its Chrysler, Jeep and Dodge brands into a new company that would be owned by the U.S. government, Fiat SpA (FIA.MI) and the company’s workers.

The plan, however, depends on U.S. Bankruptcy Court approval of the sale, and this group of lenders feels the current plan to sell those assets within 30 to 60 days may infringe on their legal rights.

“We’re just standing on the law,” said Tom Lauria, a bankruptcy attorney at White & Case, representing a group of about 20 Chrysler first lien senior secured lenders.

“They (Chrysler) say they are going to allocate out and distribute the proceeds of the sale in a way that they couldn’t do if they were going to do it under a Chapter 11 plan,” he added.

The group of lenders Lauria represents includes Oppenheimer Funds, Stairway Capital and other secured lenders who have their own group of investors, including teachers’ credit unions, pension funds, retiree plans, college endowments, and retirement funds.

He said the group understands the need for Chrysler to sell itself and for the industry to restructure, but owes a fiduciary duty to its investors and objects to the way Chrysler is trying to divy up the proceeds of the bankruptcy sale without putting it to a creditor vote.

“This is not an objection to rescuing Chrysler, Lauria said.

Rather, Lauria said, Chrysler’s proposed plan “inverts” the classic priority scheme written into the bankruptcy code, where senior secured creditors are paid in full first, followed by junior lenders, administrative claims, unsecured lenders and equity holders.

“The sale is an attempt to end-run the procedural protections that are provided to stakeholders by Chapter 11,” he said.

“What’s happening is the senior secured creditors are going to get 29 cents on the dollar and the unsecured creditors are going to get $10 billion dollars.”

Lauria said his clients had viewed the quality of their collateral as secure and took correspondingly low interest rates on their loans to Chrysler because the loans were “seemingly secure.” But now the lenders find themselves effectively subsidizing more junior creditors, in a way that would not typically occur under the bankruptcy code, Lauria said.

. . . .

“Based on the pressure the administration has put on a number of my clients who have received no TARP funds in the last 24 hours, I cannot imagine the pressure that it brought to bear on the lenders in our group who received TARP funding,” Lauria said.

“I’ve never seen the President of the United States personally thrust himself into a bankruptcy case. The executive branch is going to be present in the court and it will really put pressure on the court to demonstrate to the people of this country that it’s watching what’s going on in an independent and unbiased way.”

In a televised appearance from the White House, Obama termed the dissenting Chrysler debtholders “speculators” who had endangered the automaker’s future by holding out.

“I don’t stand with those who held out when everybody else is making sacrifices. That’s why I’m supporting Chrysler’s plan to use our bankruptcy laws to clear away its remaining obligations,” Obama said.

The part about “us[ing] the bankruptcy laws” is particularly rich, as the aggrieved creditors are clearly standing on the bankruptcy laws, and numerous precedents thereunder, while the UAW and the administration are just as clearly doing everything possible to subvert those laws and precedents.  

Selective intervention of this sort has consequences.  Any potential lender or investor to any politically sensitive firm will certainly raise his/her estimate of the likelihood that their investment will be expropriated if it serves the interests of this administration, or some future one.  The cost of finance, both debt and equity, will rise accordingly.  

The main saving grace here is that there is a possibility that an independent court will slap down this usurpation.  That is what–so far, anyways–has kept this country sliding down too far on the path towards an unconstrained executive, and away from a rule based system in which personal liberties–including property rights–are protected from the awesome power of the state.  The Supreme Court did so when overturning the NRA in the poultry case, and in ruling in the Youngstown case against Truman’s seizure of the steel industry during the Korean War.    

We’ve seen what happens when the power of the government favors organized labor in the airline industry, and the railroad industry before that.  It was not pretty.  In the case of the airlines, it is still pretty ugly.  

So, where will the effect be biggest?  Right now, I’d say Ford.  The company has been relatively fortunate, but it will definitely face higher capital costs going forward.

 Another industry worth watching is the banking industry.  You know, the one that needs massive recapitalization.  Maybe in the 12-13 figure range.  No big deal.  Sure you’ve read about it.  

In banking, the schizophrenia is manifest.  On the one hand, the government is reluctant to permit the operation of existing processes and precedents that would impose losses on bank creditors, thereby permitting undercapitalized banks to continue to operate without necessary restructuring.  On the other, in the auto industry it is taking actions that undermine the ability of banks to attract new capital by undermining the law’s protections to creditors.  That is, it is taking actions that run roughshod over the operation of rules governing the disposition of firms in financial distress, in one instance protecting creditors, in the other screwing them.  But it is protecting from the effects of the law those who don’t deserve protection, and attempting to deny its protections from those who do.  

And no.  These things don’t average out.  

This greatly increases the uncertainty and unpredictability in the capital markets.  It means that we are transitioning from a largely rule-driven system, albeit an imperfect one, into a discretionary, political-driven system.  As ugly as the bankruptcy process is, at least it is a process, and one that offers some protections.  Executive extemporization based on political calculations is the antithesis of process.  The resulting increase in the risk/uncertainty will have huge effects on contracting going forward, and will tend to impede investment and growth.  

Some pooh-pooh these problems.  Felix Salmon, for one:

Oh come  on. When Detroit raised debt capital in the past, its lenders weren’t operating on the assumption that they would be paid off in full before the UAW got a penny — and if they were, they were being foolish in the extreme. The UAW, after all, is necessary for the continued existence of the company: they’re doing the equivalent of putting new money in to the operation, in the form of their labor going forwards. I don’t see the creditors offering to put up any new capital.

Sure, the creditors might have a point about seniority if the firms were to be liquidated with the loss of all jobs. But let’s not forget that a huge part of the reason why they lent their money in the first case was that the US auto industry is systemically important, and that the government would never allow it to be liquidated. They were making a moral hazard play, and believed the car companies when they said that bankruptcy would be disastrous, and so they assumed that the government would keep the car companies out of bankruptcy.

Where to begin?  Time is at a premium, so I will just make a couple of comments.

Re “[w]hen Detroit raised debt capital in the past, its lenders weren’t operating on the assumption that they would be paid off in full before the UAW got a penny”: “paid off in full” is a straw man (very Obama-esque of Salmon, BTW, for Obama is the master of the straw man gambit).  No doubt they were operating under the assumption that in any renegotiation or bankruptcy procedure, the normal horsetrading would mean that unsecured creditors would receive something, and that they secured creditors would take a haircut.  But no doubt they were also not operating under the assumption that the government would attempt to undermine completely their contractual and legal protections, and exert tremendous pressure to force bondholders to subsidize the UAW to this extent.  

Re “[t]he UAW, after all, is necessary for the continued existence of the company: they’re doing the equivalent of putting new money in to the operation, in the form of their labor going forwards [sic]. I don’t see the creditors offering to put up any new capital.”  Uhm, I’m pretty sure they are going to get paid for their labor going forward.  Any concessions re wages and benefits?   Apparently not.  This is about the priority of an unsecured claim that the UAW willingly agreed to in the past, and whether that priority should be honored going forward.  (And, insofar as the UAW’s necessity for the company’s continued existence is concerned:  It is largely responsible for its current predicament, and its increased dominance will hamper the company even more going forward.)  

Re “moral hazard play” and “liquidation”: Another straw man.  Pretty Olympian of Salmon to put himself in the minds of myriad bond investors.  Moreover, he suggests that seniority matters only in liquidation.  But, first, neither ex ante or ex post would anybody consider full liquidation a likely outcome.  Second, seniority affects bargain power, and hence payoffs, in restructuring outside of bankruptcy, and within bankruptcy.  An unexpected, ex post attack on seniority therefore transfers wealth from one group to another even outside of liquidation.  

The key word here is “unexpected.”  If this heavy handed intervention was unexpected–and it seems pretty clear that it was–after observing it rational investors will revise their estimates of likely outcomes involving future politically connected, financially distressed companies.  In particular, they will revise their expected payoffs downwards.   They will revise upwards their estimates of transactions costs and risk.  All of these effects will inevitably lead to higher capital costs for this kind of firm.

Salmon calls this argument a “groaner.”  Sadly, he’s the one who deserves the groans.





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  1. It seems to me that the Empty Suit can blather and suck up to his union voters all he wants, but, the federal bankruptcy court will follow the law. That debt holders that are getting the shaft will be well lawyered.

    This whole cobbled together scheme is ridiculous.

    Chrysler + Fiat, now that’s a laugh, how well did Chrysler + Daimler work out?? It’s a stupid synergy. Neither make a car Americans will buy. And, the UAW owner/manager/floor worker isn’t going to be any more productive or willing to deeply scale back their salaries and lavish benefits that helped drive the industry into the ground. Chrysler is finished no matter how much perfume you put on that pig.

    Next up is GM. Hey, after that there is the whole newspaper industry to save.

    Comment by penny — May 1, 2009 @ 5:04 pm

  2. If you don’t like the elected Obama Administration to be involved in the Chrysler case, tell Chrysler to bail itself out next time with private capital. Instead, they and GM came to the public trough to save jobs, some, but not all, maybe not even most when considering all the suppliers, are represented by the obscenely over-compensated UAW.

    “to serve the interest of an unsecured creditor, the UAW, which just happens to be the Democrat Party’s Siamese twin:”

    No sir, to prevent a massive cascade of layoffs, which is an effort in the nation’s interest.

    Comment by John Freeland — May 1, 2009 @ 8:02 pm

  3. John–

    Very confused by your comment. Do you oppose a bailout to save Chrysler (and GM) and the “obscenely over-compensated UAW”, or do you support it to “save [the] jobs” of those same obscenely over-compensated people? Depending on which sentence I read, I come to different conclusions.

    Go back to some of my earlier posts, and you’ll see that I opposed the bailouts. I still do. Pouring good money after bad is a terrible idea. Under the elected Bush administration, as under the elected Obama administration, I was/am fully in support of telling Chrysler to bail itself out with private capital, and if that couldn’t/can’t happen–fare thee well in bankruptcy. That’s what it’s there for.

    And, I also am not quite so sure that the structure of the Chrysler deal will actually save jobs. Going forward, the viability of Chrysler as an employer will be driven by the overall economy and competitive outcomes in the auto market. A union owned and controlled Chrysler will not be able to continue to pay too many people too much to produce cars nobody buys. It can’t suspend economic reality. Fact is, Chrysler employment will shrink. The only way it won’t shrink is if (a) the union gets costs under control, or (b) the US gov’t implements some protectionist measures.

    And, ironically, this move by Obama will make it more difficult for Chrysler to attract the private capital necessary to be a viable employer going forward.

    The structure of the deal actually seems more oriented towards serving the interests of retirees and those who will soon retire.

    Bottom line. This deal will not make Chrysler viable. It’s effect on Chrysler’s ability to employ people will be minimal. That will be determined by the market. The main effect is to subvert well established priority rules in order to redistribute wealth from bondholders to Chrysler retirees and older workers. And that subversion will have effects that are decidedly inimical to the natural interest.

    The ProfessorComment by The Professor — May 1, 2009 @ 10:04 pm

  4. John, how about letting Chrysler disappear so that capital can flow to a more viable and deserving business. And, long term the job losses thanks to the Obama administration’s misallocation of taxpayer money will be more profound and longer lasting, maybe even multi-generational. Intelligent use of capital is in the long term interest of this country. It’s the best source of creating jobs.

    The suppliers and parts manufacturers will shift to Honda, Toyota and Ford when the dust settles. Americans will continue to replace their cars even if Chrysler and GM are gone. Both Toyota and Honda have plants here. You can bet they will expand them to fill the gap creating more employment.

    Comment by penny — May 2, 2009 @ 9:41 am

  5. A few points:
    1. I don’t believe that UAW workers are obscenely overcompensated but it seems like you and Penny do.
    2. You appear to be saying that the bondholders are secured under the terms of their legally sacrosanct investment contract and should be made whole as the bankruptcy moves forward.
    3. The UAW contract is dispensible under the bankruptcy rules. Their contract can be trashed, the union busted, many of its members losing their homes resulting in more foreclosures, communities losing economic base, and a cascade of related economic events.
    4. Protectionism is rampant. The Chrysler-GM bailout is small potatoes. TARP, begun in the Bush Administration, is hugely protectionist.

    Comment by John Freeland — May 2, 2009 @ 10:22 am

  6. “The key word here is “unexpected.” If this heavy handed intervention was unexpected–and it seems pretty clear that it was–after observing it rational investors will revise their estimates of likely outcomes involving future politically connected, financially distressed companies. In particular, they will revise their expected payoffs downwards. They will revise upwards their estimates of transactions costs and risk. All of these effects will inevitably lead to higher capital costs for this kind of firm.”

    Gosh, does the mean the end of 30-1 margins?

    Comment by John Freeland — May 2, 2009 @ 11:51 am

  7. John, autoworkers are ridiculously overcompensated measured against any other blue collar worker:

    The UAW employee cost is about $2,000 per car as per a WSJ article this week.

    And, what makes UAW workers so special that they should be exempt from the financial pain and job loss that has happened in the financial, retail and construction sectors? Besides, their protectionist union status, I mean?

    Newspapers are laying off and folding, so we taxpayers subsidize them too?

    Approximately $450 billion dollars has been lost by the automakers in profits in the past decade, long before this crisis took hold. You still haven’t addressed my point that the efficient use of capital going from the failed to the more viable and stronger industries, companies ultimately benefits us all.

    All that has followed since the inception of TARP which was limited in scope to saving the banking industry has got nothing to do with Bush. Obama and the Democrats have ownership of the economy now.

    Comment by penny — May 2, 2009 @ 2:19 pm

  8. Penny:
    I’m not sure what constitutes “more viable and stronger.” Companies opperate under a given set of conditions, which change over time. Standard Oil in the early 20th century was probably “more viable and stronger.” It was also a kind of cancer.

    I’m not here to defend the American car companies, but I do get irritated when I hear people complain about blue collar workers getting paid too much. Over the last 30 ears or so, union membership has steadily declined, manufacturing jobs have been lost to globalization, financials have become a bigger part of our economy, and upper incomes have increased at far greater rates than middle and lower incomes. The U.S. Gini coefficient has steadily risen, opening a gap between the affluent and the rest, effectively feeding a growing polarization of our society – in my view.

    The original post here was entitled “So much for secured.” Evidently some investers had a contract that entitled them to a certain return on their investment. The union also had a contract, which is being shredded. Both will be addressed to some extent in the bankruptcy proceedings. It’ll be interesting to see how it plays out.

    Comment by John Freeland — May 2, 2009 @ 9:14 pm

  9. John–

    I’m still confused. I didn’t bring up “obscenely over-compensated.” Nor did Penny. You used the term. Upon re-reading, perhaps you are referring to UAW management as being overcompensated, rather than the rank-and-file. But still . . . very confusing.

    Penny is right on point re the colossal waste of capital in the auto industry in recent decades. Michael Jensen of Harvard has documented in detail the value destruction in the US auto industry. Huge wastes of capital–capital that could have and should have been used to raise the productivity, and hence the wages, of workers in other industries.

    It is also abundantly clear that due to the anti-competitive effects of unionization, autoworkers are paid more on a skill-adjusted basis that workers in other industries. And a good portion of that is excess paid by people earning lower wages who have to pay more for autos as a result of this, and other auto union & company friendly policies (e.g., various trade restrictions). Furthermore, restrictions on entry of labor into certain firms/industries increases the supply of labor in other industries, thereby depressing wages there. So, much of the largesse earned by unionized workers comes at the expense of other working people.

    Re secured. My objection, quite clearly, was that the administration, and Obama personally, interjected in a way to try to prevent the adjudication of various contractual claims in bankruptcy. Investors did not expect a certain return. That’s asinine. What they did expect is that the payoffs on their investments would be determined by the application of certain rules and procedures, which Obama tried to undermine in order to benefit a favored political constituency. He wanted to short circuit the bankruptcy process, and deprive investors of the protections that they had counted on when making their investment. And he is still trying to do it, by leaning on banks that received TARP bailouts to go along with a bankruptcy plan that favors this same constituency. And making other threats to intimidate other investors without TARP strings to do the same. This is an unconscionable injection of executive power into a commercial and legal process.

    In other words, changing the rules of the game in this way will have consequences. And they will not be good.

    And as I note in my post, this will make it all the harder for some industries to attract capital, and make the capital they do attract costlier (to reward investors for the additional risks that result from the erosion of contractual rights due to the exercise of executive power). To the detriment of workers in those industries, I might add.

    So, you can’t rationalize this as a pro-worker policy. It is pro a certain, very unrepresentative and favored group of laborers, and antithetical to the interests of many other working people.

    The ProfessorComment by The Professor — May 2, 2009 @ 10:03 pm

  10. no one mentions that it is a private corp involved -Cerberus. A very wealthy private corp that is operated ore or more of the GOP Administration past. The yhav billion and doesn’t the
    deal made take them off the hook. Plus GMAC is 49% owned by Cerberus.So then GM is scrod…

    Comment by larryp — May 3, 2009 @ 1:18 pm

  11. […] Chicago politics as Obama interferes in the Chrysler bankruptcy. So Much for "Secured". […]

    Pingback by US politics - Hamsterwheel - Page 144 - PPRuNe Forums — May 3, 2009 @ 1:28 pm

  12. Someone here is missing the point, and constantly trying to change the subject.
    Fundamentally, the issue is an extralegal, executive assumption of power that doesn’t exist, is being manufactured of whole cloth, and is outrageous; any attempt at subverting the Law in its settled and established repose is Fraud.

    Having a very large constituency with a huge vested interest in the ongoing health of a dead horse, the President is rewriting Federal Code; the size of the political obligation doesn’t in any way mitigate the extent of the Fraud.

    Obama is a glib and dangerous man, usurping the Legislative Branch’ duty to make law is one thing, and even laughable, but ignoring existing Code to benefit friends is counter to his own Duty under the Law.

    Comment by Will Fraser — May 3, 2009 @ 5:02 pm

  13. […] erudite blogger is not quite so dramatic, and merely accuses President Obama of “usurpation.” From the Streetwise Professor: …the aggrieved creditors are clearly standing on the […]

    Pingback by Sustainable Middle Class » Blog Archive » Rebuilding Chrysler: Haircuts, Cram-Downs, and Waterboarding — May 4, 2009 @ 10:17 pm

  14. Hi,
    Why has no one mentioned that Fiat was the one Euro car company closest to the Soviet regime after WWII? Fiat built plants in Serbia, Poland and, yes, Togliatti in Russia (a town the Sovs renamed for a faithful Italian commie). Does everyone remember the “peopless cars” they produced in those countries, including the infamous Lada, now scorned by the majority of the Russian people themselves?

    No one has asked why Obama is giving this plum to Fiat, at the expense of our capital market rules in the US.

    Oh wait… Fiat (loved by Soviets and Commies), UAW (loved by…), lets stiff the evil financiers; oh…


    Comment by Kavkazwatcher — May 6, 2009 @ 6:50 am

  15. There is no question that all of this Obama-Bawney Fwank meddling has underlying political motivations – the Dems and the UAW, joined at the hip, Dems pandering to their partner, as a result, yet again, causing economic distortion. When the govt bailed out Chrysler the first time, it was due to a huge fear that the Pension Benefit Guaranty Corporation would go under, because Chrysler’s pensions were under-funded, thus affecting not only Chrysler pensions, but also the “safety” of all other ERISA pensions. Legislation was enacted to prohibit the then-prevailing practice of underfunding pensions. Seemed to make sense. Now, it’s just politics.

    SWP – side note, slightly off-topic, but I’d thought you’d get a kick from something from the other side of the ocean, and I didn’t know where else to put this.

    Sigma-Bleyzer report on Ukraine’s macroeconomic condition. Note that 7% of this years state budget came from 3 bcm of gas being cleared through customs – yes, the same gas that has been subject to a huge tug of war between the Tymoshenko government and Firtash-RosUkrEnergo.

    You gotta hand it to those Ukrainians – by hook and by crook, and by everything else, they’re trying to live up to their budget with the IMF.

    Here’s the link to the newspaper UNIAN –

    Direct link to downloadable pdf report:

    Comment by elmer — May 6, 2009 @ 8:34 am

  16. Not to worry, Kavkazwatcher, neither company builds a car that Americans will buy. It’s simply the Democrats throwing taxpayer money to their constituents in the unions at our expense. Obama and the Dems aren’t much better than Putin’s pigs-at-the-trough when it comes to buying patronage. And, how stupid is it if you want Ford and GM to survive to add Chrysler’s cars to a grossly over-supplied market.

    Socialists aren’t very economic savy.

    Comment by penny — May 6, 2009 @ 7:27 pm

  17. Thank you, Professor, for stating what should be clear to everybody with an education in economics, yet appears to entirely elude our rulers.

    Comment by Carl Edman — May 6, 2009 @ 8:20 pm

  18. I heard today that if Obama’s health care insurance plan is passed, that the unions will be largely off the hook for their portion/contribution for union workers health plans. It seems to me that Obama has now completed the circle by the accelerated bankruptcy,scrapping secured lender status, putting union health plans in equity positions ?, giving taxpayer dollars to a company that produces a product unpopular in the competitive auto industry, and if my first sentence is true, letting the union health care plan off the hook. Seems to me that he has now paid back the unions for electing him, by giving them a free ride at the expense of taxpayers. I may not have connected the dots correctly or have some facts wrong, so please correct away.

    Comment by Elty — June 10, 2009 @ 7:52 pm

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