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Unintended Consequences Again - Killing Any Recovery By Demonizing Investors

The Government won.  The last holdouts from the group of secured lenders to Chrysler threw in the towel late Friday and early Saturday.  This group, who held contracts in their hand which clearly stated they would be paid ahead of any unsecured claims, gave up their rights to billions of dollars in the face of political pressure so that the outcome of the Chrysler deal would fit the mold prescribed by the Obama administration.  This was not Congress.  This was a Car Czar and task force appointed by the sitting President.  There was a clear goal of what this group wanted, including which interest group would end up with what in terms of money, control, and ownership.  They won.

As the WSJ reports, it was a game of hardball, and the lenders eventually couldn’t take it. 

But this is not the end.  This is the beginning.  Every investor should be paying very close attention to how this deal evolved, because it clearly indicates a willingness to change the law midstream, picking clear winners and losers.  As the journal reports:

Senior secured lenders usually get paid in full before lower-priority creditors get anything. Not this time.

The White House’s role in restructuring Chrysler has sent a shudder through the community of lawyers and lenders in the field of bankruptcy and corporate workouts. Critics complain that the administration has violated a bedrock principle of American capitalism and unfairly demonized financial firms that are vital to the functioning of the economy and its eventual recovery.

Administration officials reply that the Chrysler crisis required bold action. While Chrysler’s suppliers, dealers and unionized workers are critical to its survival — and so is Fiat, which will contribute high-efficiency engines and foreign distribution — the creditors were expendable.

“You don’t need banks and bondholders to make cars,” said one administration official.

The administration could exert such leverage because it was convinced big banks were too tarnished in the public eye to put up a fight. They risked being blamed for Chrysler’s demise. And if Chrysler had to liquidate, they and other lenders would have to try to recover their money by selling closed auto plants and other assets that are little in demand.

“You don’t need banks and bondholders to make cars.”  Actually, you do.  You need individuals, trustees, bankers, Chief Investment Officers, and a host of others who are willing to risk their capital in order to finance such enterprises.  And they were.  And for their risk they were given a rate of return and a pledge of assets, which turned out to be worthless.  What they ended up with was whatever the government thought they should get. 

 The Chrysler deal (and GM for that matter), is politically charged because it involves a large number of jobs, American icons, unions, and a lot of negotiations over 35 years that were in the public eye and seemed to be in bad faith.  Some might think bondholders and other lenders deserve only what they got.  Some might feel they got too much because they were betting.  But it seems that those things are fleeting, where the lasting impact will be much greater, and based on what they did not get.  These lenders did not get what the law clearly entitled them to.  Which brings up two distinct problems.

First, if you as an investor hold shares of Morgan, or another bank or mutual fund that holds these secured loans from Chrysler, then in a very small way you were just told that you will sacrifice 2/3 of what you were legally entitled to for the sake of what the government wanted to happen.  Somewhere in between is an investment officer for that bank or fund who agreed with the government.  Did they perform their fiduciary duty?  Their clear role is to act in the best interest of their shareholders.  Morgan and the other banks and funds are not 100% owned by one person, they are owned by shareholders who have rights and interests.  Were those interests protected?  That’s hard to justify.

Second, every investor or person who invests on someone’s behalf will think long and hard about the next dollar committed.  Who will finance a company that might one day be a candidate for bankruptcy, considering the outcome according to the law is no longer a reasonable assumption?  What company is so secure that it is NOT a potential candidate?

Which brings us to the recovery, or lack thereof.  What every recovery needs is for investors and consumers to return.  Our views of consumers is well known.  Think about the diminishing potential for large investors to put capital at risk at the margin of safety, where it is needed most.  Who will do this when the normal guarantees and assurances from the company no longer apply?