Streetwise Professor

May 8, 2009

The “Social” Scam, Chrysler Edition

Filed under: Derivatives,Economics,Financial crisis,Politics — The Professor @ 1:27 pm

Today is the 110th of Hayek’s birth.  Reading a couple of items in the FT brought to mind one of Hayek’s most trenchant observations.  Specifically, Hayek was extremely suspicious of the use of the word “social” as a modifier.  He viewed it a a meaningless appendage at best, a means of undermining (or intimidating the exercise of) independent thought at its worst.  Hayek believed that the positive connotations of the word “social” were used to justify profoundly illiberal, and at times oppressive, actions and policies.

The s-word is cropping up a lot in discussions of the Chrysler bankruptcy, and the administrations attempts to strongarm those standing on their contractual rights.  One example:

“The financial interests of investors may conflict with what the government is trying to do from a social perspective,” says Steve Persky, managing director of Dalton Investors, a Los Angeles-based hedge fund that specialises in distressed debt.

And another:

The message that all the constituencies involved in Chrysler must share in the pain originated in the White House. “The government played a very strong hand,” says the person representing one agent bank. “All the senior lenders got the short end.

“The government had one eye on the social element and one eye on not abrogating contracts, but can you reconcile these two goals?”

Translation: “social perspective” and “social element” mean policies intended to benefit one group of individuals at the expense of another, but that the beneficiaries are called “society” and the victims of the redistributive policy are by implication “anti-social.”  I can’t think of a better example of Hayek’s warnings about the use of “social.”

No, the 60,000 Chrysler workers are not “society.”  They are a politically favored group.  And no, the senior creditors are not “anti-social.”  They are individuals and firms whose contractual rights are being threatened.

Indeed, the insinuation that the deprivation of a small number of individuals’ contractual rights is somehow necessary to achieve larger benefits for “society” turns reality on its head.  By undermining the security of contract to benefit a small, politically favored interest group, these actions will reduce the wealth of Americans–and indeed people around the world–by a far larger amount than it will increase the wealth of the Chrysler workers and retirees.  It will raise capital costs and transactions costs throughout the entire economy, making most of us far poorer (except, perhaps, for lawyers and lobbyists).   The rule of law and contractual rights are essential to the production of wealth, and to economic growth.  Undermine these, and less wealth will be generated, today and in the future.  

And, to provide some perspective on how the word “social” is used to rationalize robbery, here’s a wonderful quote from Obama’s Book Club buddy, Hugo Chavez, rationalizing the expropriation of oil services firms who actually had the temerity to demand payment for services rendered (can you believe?):

“Tomorrow we’ll start recovering the goods and assets that will now belong to the state — social property as it always should have been,” Mr. Chávez said in a televised speech Thursday. “Mr. Man on the moon, cover your ears because the cries of anguish from the bourgeoisie will reach all the way to the moon.”

We’re not Venezuela or Russia yet, by any means, when it comes to undermining property rights.  We still have independent courts.  But the administration’s (and Congress’s) disregard for property rights, and its willingness to run roughshod over them to benefit certain political constituencies promoted to the rank of “society” is an ominous precedent.

As is the other news in the second FT article quoted above.  Namely, the use of big banks dependent on the government to serve as the enforcers of the government’s will:

But whatever the final ruling, the talks last week illustrated that four banks, led by JPMorgan, which acted as agent for the loan, were acting to advance the government’s agenda, according to people familiar with the talks. The core lenders, which also included  Morgan Stanley,  Goldman Sachs  and  Citigroup, have all taken taxpayers’ money through the troubled assets relief programme.

The efforts of Mr Lee at JPMorgan, which originally had $2.7bn of Chrysler debt, were supported by the three other agent banks, Citi, with about $900m in face value of loans, Morgan Stanley and Goldman Sachs with well under $600m each. Mr Lee declined to comment.

The four banks divided up the work of contacting other creditors, with each calling those with whom they had the strongest relationships, the people familiar said.

In some cases, the large banks were lenders to smaller Chrysler creditors, in others, they had sold them the Chrysler debt. “There was a lot of high drama stuff,” recalls one creditor. “There was a lot of we will never do business with you again kind of talk.”

That can be standard in the tough negotiations over the fate of troubled borrowers. But in this case, there was another element. In an illustration of how dramatically the financial world has changed during the financial crisis, bankers from the agent banks say they felt under pressure from the US government.

This is the kind of abuse of effective government control over large financial institutions that has led me to oppose nationalization as a means of addressing bank insolvencies.  We again seem to have the worst of both worlds: the government gives every impression of being captured by the major banks when it comes to dealing with insolvency (I hope to write about the stress tests in a bit), but exerts pressure on them to divert resources to its favored constituents.  And perhaps this is the disturbing quid pro quo: the banks get the opportunity to gamble themselves out of trouble, and in exchange, assist the government in undermining contracts so as to benefit its favored interests.

Like I’ve said.  These things don’t average out: being too nice to the banks on some things and leaning on them in others is to commit two errors that compound, rather than offset.  (Like the old lawyer joke: “I’ve won cases I should have lost.  I’ve lost cases I should have won.  Therefore, on average, justice has been served.”  No.  It’s been dis-served twice.)

To close the circle, this quote from an article about science prizes illustrates perfectly Hayek’s warnings about the low and dishonest rhetorical use of the word “social”:

“I hate these inducement prizes and their language of social benefit,” says University of Pennsylvania prize scholar James F. English, author of “The Economy of Prestige: Prizes, Awards and The Circulation of Cultural Value.” “It’s a cover for what they are really about, which is getting attention. I don’t think that kind of small-scale frantic prize-chasing investment is the best way for us to solve big problems.”

Different context, to be sure.  But a wonderful illustration of Hayek’s point that when you hear the word “social” being used, be very, very careful.  There is a very good chance you’re either being played–or intimidated into silence.

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  1. Street smart people do not invest in unionized businesses.
    Those who do are either liberals or plain dumb. In either case should be separated from their money invested in the Big Three automakers.
    The best option is bankruptcy and reorganization. Clean the balance sheet. Dump the dumb where they belong. Taxpayers should not pay for their stupidity.

    Comment by Michael Vilkin — May 9, 2009 @ 11:36 pm

  2. OK, let me offer a correction.

    “The efforts of Mr Lee at JPMorgan, which originally had $2.7bn of Chrysler debt, were supported by the three other agent banks, Citi, with about $900m in face value of loans, Morgan Stanley and Goldman Sachs with well under $600m each. Mr Lee declined to comment.”

    It’s possible that those who invested in Big Three debt are neither liberals nor dumb. It’s possible that the government (democ rats in Congress?) quietly forced them to invest in Big Three. Because in the end who will lose most money? Stockholders of those banks. They already lost much more money than total debt of the Big Three combined. I just can not believe that reasonable people would invest billions of dollars in the Big Three without some kind of pressure.

    Comment by Michael Vilkin — May 9, 2009 @ 11:57 pm

  3. I realize this is now ancient history, and moot — but I’m still curious about a few things, and would greatly appreciate any help that anyone can provide.
    That is, if the contractual rights of Chrysler’s debt-holders — financiers & investors — are sacrosanct, and not to be abrogated even when there aren’t sufficient funds to pay them, then why aren’t the employment contracts of Chrysler’s employees equally untouchable?
    Contrariwise, if it’s right, proper, legal, and just for the employment contracts of the employees to be abandoned, because of a lack of funds, why isn’t it equally right to let the investors bear some of the loss as well?
    If anything, as long as we’re going to argue that different “stakeholders” in a failing firm can and should have different terms applied to their claims, instead of all being treated in the same way, I’d think that investors should be the first to have to take a bath (sorry, I think the metaphor most in use at the time was about haircuts, not baths). After all, the two reasons they get paid for the use of their loaned / invested money is first, because it’s a resource of value, the use of which must be compensated, and second, because of the risks of loss, should the firm run into trouble. But if there’s no risk — if the law can force even insolvent firms to pay their financiers back in full — then why is there the famous “risk premium” attached to some forms of investment over others — but attached to all investments to at least some extent?
    That’s the classic and obvious injustice of the heads-I-win-tails-you-lose variety — and you’re suggesting that the government should be enforcing that? I’d think the last thing freedom-loving libertarians would want is for the tax money of hard-working Americans to be blatantly interfering in the workings of the market.
    Especially as the employees are compensated for the labor they provide to the firm — they didn’t sign up for any risk, and they’re given no risk premium in their pay. How is it justice that they get the shaft when hard times hit, but the people and corporate entities who have been well-paid to take on risk should bear no actual loss, even when it’s clear they’d made some bad bets?
    Clearly, of course, I must be wrong in all of these theories, as they’re all the direct opposite of your points above.
    So how am I wrong, exactly?
    Why are contracts with the money-men sacrosanct, and their funds assured even though they were paid specifically to take on risk, while the contracts with the people who get paid for their work, and not for taking on risk, are not?
    I await any answers eagerly, and greatly appreciate any education and correction that anyone can provide me.

    Comment by smartalek — October 18, 2011 @ 8:25 pm

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