Streetwise Professor

In my first post on the Obama administration’s flouting of creditor priorities in the Chrysler bailout/bankruptcy, I argued that a likely consequence would be to impair the ability of firms with substantial union membership (e.g., Ford, the airlines) to obtain credit.  Now numerous financiers have rendered a similar verdict:

Hedge fund managerGeorge Schultze  says he may avoid lending to any more unionized companies after being burned by President Barack Obama in Chrysler LLC’s bankruptcy.

Obama put Chrysler under court protection on April 30 after lenders balked at a proposal giving them about 29 cents on the dollar for their $6.9 billion in debt. The investors said the president’s plan favored a union retiree medical fund whose claims ranked behind them for repayment. It was offered a 55 percent equity stake in the automaker.

Pacific Investment Management Co., Barclays Capital and Fridson Investment Advisors have joined Schultze Asset Management LLC in saying lenders may be unwilling to back unionized companies with underfunded pension and medical obligations, such as airlines and auto-industry suppliers, because Chrysler’s creditors failed to block Obama’s move. The reluctance may put additional pressure on borrowers seeking capital in the worst financial crisis since the Great Depression.

“Lenders will have to figure out how to price this risk,” Schultze, 39, said in a telephone interview from his office in Purchase, New York. “The obvious one is: Don’t lend to a company with big legacy liabilities or demand a much higher rate of interest because you may be leapfrogged in a bankruptcy.”

. . . .

‘Rights Were Trashed’

Jack Welch, former chief executive officer of General Electric Co., criticized how the government handled Chrysler’s bankruptcy, saying unions were favored at the expense of creditors.

“I didn’t like the terms,” Welch, 73, said in an interview yesterday at the Boston Convention Center. “The creditors’ rights were trashed and the unions got 55 percent of the company.”

. . . .

‘Justifiably Concerned’

“Creditors are justifiably concerned” about what precedent the auto bailouts are setting, said  Mark Kiesel, global head of corporate bond portfolios at Pimco in Newport Beach, California. Pimco managed $747 billion as of Dec. 31.

“When you get these companies that have legacy costs, that’s something you have to factor in when evaluating credit risk,” Kiesel said. “Any investor is going to price in increasing political risk in considering where to put their money.”

Pimco, manager of the world’s largest bond fund, didn’t have a stake in Chrysler and owns an “infinitesimally small” amount of GM debt, according to a  report  by co-chief investment officer  Bill Gross  on the firm’s Web site.

The government’s “grassroots trend” signals “an increasing uncertainty of cash flows from financial assets” and risk premiums will increase as a result, Gross wrote.

Warren Buffet has expressed similar concerns.  (Irony alert: I am no big fan of Buffet, Jack Welch, or Bill Gross.)  

This is actually pretty obvious, but the resulting dynamic may be far more obscure, and insidious.  Unionized firms with limited access to capital are more vulnerable to financial distress.  And under the current administration, they are likely to receive Federal support, furthering government control over the economy.  (Government support may include direct financial support, but also regulatory changes or tax advantages.)  

When I was a kid, Jay’s Potato Chips had an ad: “You can’t eat just one.”  There are some similarities to bailouts, and to the erosion of contractual rights.  Once that process starts, there is a feedback mechanism that raises the likelihood there will be more.  And the Chrysler fiasco has started that process with a bang.