When banks have no reputation left to lose

By Felix Salmon
April 21, 2009

The government wants Chrysler’s bank lenders to take a steep 85% haircut on their debt. The banks have now come back with an aggressive counteroffer, saying they will accept no more than a 35% haircut, and even then they want Fiat to put new money into Chrysler and they want a 40% equity stake for themselves to boot.

It doesn’t make a lot of sense that the banks, which are so dependent on Treasury, should be playing such hardball. But it turns out that it’s not the banks who are being particularly tough here, so much as the hedge funds holding bank debt:

The larger lenders were pushing for a counteroffer that was closer to the original government proposal than smaller lenders, such as hedge funds, were willing to agree to, said these people.

This conflicting view is likely due to several things, such as the fact the larger banks paid full price for billions of Chrysler bank debt, while smaller holders bought theirs at a steep discount and would likely make a tidy profit even in a quick liquidation of Chrysler, said people involved in the talks.

“Not everyone was on the same page. The big-bank view was ‘Hey guys, the offer back can’t be outrageous. This is the government,’” said one of these people. “There were others, smaller lenders, who wanted to be a lot more aggressive.”

I had to read this twice before I understood it: the big lenders who bought the debt at par were the ones pushing for a larger haircut, and therefore larger losses. Meanwhile, the small lenders who bought the debt at a discount and who are likely to make money whatever happens (thanks largely to the fact that the government continues to throw money at the automakers, in the face of recalcitrance from Detroit itself) are the ones who are trying to squeeze every last penny out of Chrysler: they couldn’t be conforming more to hedge-fund stereotype if they tried.

There’s a broader subtext, though, I think, to this counteroffer, which comes from the biggest names in US banking: JP Morgan, Citigroup, Goldman Sachs, and Morgan Stanley between them hold $4.3 billion of the $6.9 billion in debt, and are ultimately calling the shots. They’re saying that they’re perfectly happy to see Chrysler descend into a chaotic and destructive liquidation, because they’ll still end up with more money that way than they would if they accepted the government’s offer.

I daresay they’re narrowly right on that front, since the government’s injection of TARP funds into the automakers is a done deal and the banks would essentially be taking a large part of that money for themselves, rather than putting it towards supporting the Detroit car industry as a going concern.

From a public relations perspective, however, gratuitously driving a company as storied and economically important as Chrysler into bankruptcy is generally not the kind of thing that any bank wants to do. Unless, that is, banks in general have already hit the zero bound in terms of reputation. Call it the Ticketmaster strategy: you can do anything you like once everybody hates you.

This is what happens in a world of class warfare: the banks get demonized and hated on so much (and justifiably so, much of the time) that they no longer care about things like whether or not they’re driving the final stake into the heart of the Midwest’s manufacturing economy. Which might not be a reason to be nicer to them, but at least it might be a useful tactical consideration to bear in mind. Since they certainly seem to be feeling that they have very little to lose any more.

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