Ignore Detroit’s bondholders’ whines

By Felix Salmon
May 1, 2009

I’m frankly surprised at the amount of pushback against the entirely sensible notion that Chrysler’s creditors (and, by implication, GM’s as well) should accept an enormous haircut on their failed investment.

You can tell an argument in favor of the holdout bondholders is on thin ice when the people making it wheel out the old groaner about future capital access. Here’s Liam Denning:

If the current plan is pushed through, then good luck to any unionized firm trying to raise secured debt on decent terms in the future.

Here’s Breakingviews:

Years of bankruptcy law have put secured creditors at the top of the pecking order, inducing them to put capital at risk. Vilifying investors who held firm to this conviction may have the reverse effect.

And here’s Joe Wiesenthal:

It should certainly make anyone think twice before lending money to a company with a strong union.

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.

So now I can barely believe it when the creditors start talking about how much they might receive in liquidation. For one thing, I don’t believe them. If GM and Chrysler liquidate, their assets are worth very little if anything at all: how are you going to monetize a mothballed production line? And insofar as the liquidation value is positive, it only gets to that point by dint of taxpayers picking up most of the costs of liquidation: soaring unemployment in the rust belt, an even worse economic depression in the hardest-hit areas of the country, and so forth. It’s a bit like the Wal-Mart model of paying your employees so little that they’re eligible for Medicaid, thereby getting them “free” healthcare, and Barack Obama is absolutely right to reject it.

I also heard an interesting new twist in this argument last night: the idea that the government is repaying itself in full while imposing massive haircuts on other creditors. No it’s not. It’s getting an 8% stake in the new Chrysler, which is worth roughly zero, in return for the billions it’s pumping in to the company — and it’s worth remembering that the $2.25 billion that the creditors were going to receive was going to come directly from the government, not from Chrysler itself. And no, the creditors would not need to pay that money back.

Of course aggressive creditors are going to want to maximize the value of their claims, both in bankruptcy court and in the press. But if this is the best they can come up with, I think it’s safe to dismiss their whining as the bleating of the sore loser.

Update: I forgot to mention the other old chestnut which indicates that there’s really no substance to the complaints. Here’s John Gapper:

Some of these “speculators” inconveniently manage money on behalf of pension plans and endowments, rather than rapacious rich people.

And here’s Wiesenthal, again:

If you’re a teacher or any state employee or anyone who has money in a pension or gets money from an endowment, there’s a decent chance that you’re invested in a hedge fund.

The “hedge funds represent normal people too” argument is so vacuous it’s not really worth responding to — except to note that it’s being made, and to cite some kind of rule that the minute anybody makes it, they can automatically be assumed to have lost the debate. If you’re going to set up a cage match between hedge funds, on the one hand, and the UAW, on the other, I think it’s pretty clear which side represents rich capitalists and which side represents people without much in the way of savings.


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Also, as this Bloomberg article (http://www.bloomberg.com/apps/news?pid= 20601109&sid=aowmZkX0TzEE&refer=exclusiv e) points out, the absolute rule of priority can be overruled in bankruptcy court anyway. The hold-outs decided to play a game of chicken and they lost. End of story. If they continue trying to stall the process in bankruptcy court in order to persuade the government to pay them off with a better deal, I have a feeling they are going to end up with even less. These once-proud financial titans have still not quite come to grips with the new world that they’re living in. Don’t they realize that they’re setting themselves up as sitting ducks for any politician who’s looking for a convenient scapegoat for populist ire?

Posted by Nate | Report as abusive

I think the UAW played a game of chicken and lost. The judge may not be as sympathetic to their claim that they deserved more of Chrysler than the SECURED debt holders. What asset was pledged as collateral for the UAW? NONE Same story as for GM. Why does the UAW get preferential treatment to the lenders that lent the UAW the money for their benefits?

Posted by gsorter | Report as abusive

Very well said – the other issue not being spoken of is how the other side is comparing the PAR VALUE of the bonds with the full amount that the government put in when they knew bankruptcy was a distinct possibility (they are saying that Bondholders are getting 10 cents on the dolar whiel the goverment is getting 87). So although the bonds were trading at 25 cents, why not use $1 to try to make a point (see yesterday’s WSJ op-ed). If I buy chrysler debt at 20 cents and get offered 20 cents for it, can i say I am only getting 20 cents on the dollar, while the government is getting 87 cents? Wouldn’t it be more fair to at least use the market price of the debt on the day of the government loan?

Posted by bruce fields | Report as abusive

Where do you live, Salmon? Nazi land? The bondholders absolutely have a right to stall this process. It wasn’t their idea and nobody asked them if the Federal Gov’t had the right to shove a “loan” down their throats and take over their company. Are you really so ignorant that you don’t recognize the reason obama took control of these companies was to “save” the unions? Are you really that out of touch?? You just don’t get it, do you. The unions broke the big three. I knew it when they provided these golden parachute contracts back in the 70′s, it was just a matter of time. The best way to revive the auto industry is to crush and remove the unions. They are currupt, dirty, criminals that add nothing to the industry. They pray on the stupid and cater to the fat and lazy who believe someone else should provide their livelihood. And try to get this straight, UAW mouthpiece, I’m talking about the UAW, not the workers. I don’t feel sorry for anyone stupid enough to loan the big three money, but allowing the unions to skate is unacceptable. They are the problem, stupid!! Typical Reuters bull.

Posted by Doug Mortenson | Report as abusive

From a cold, “what does it take to make Chysler into a going concern” perspective, why are the UAW retirees getting preference? For that matter, why is the UAW?

If you cast aside political issues and just wanted to make Chrysler into an operative car company, wouldn’t it be best to burn the retirees AND the bondholders, neither of whom are making cars, and to rip up the UAW work rule agreements?

Posted by J Mann | Report as abusive

The solution would have been for the creditors, UAW, and government, to have purchased CDSs on GM.

Seriously, well, sort of, when all sides are exaggerating as much as this, it means that each side has some good points, and that the decision will be a mess. Depending upon how you look at it, all sides are winners and losers.

That’s not bad. Hell, usually, I’m just a loser.

Ah, but is it legal? If the holdouts hold senior securities then don’t they have a completely legal right to demand that their senior securities be paid in full? Isn’t that really the point of buying first tier senior securities? And don’t bankruptcy courts usually follow the rule that Senior securities are paid off first? Secondly isn’t it the duty of these hold out funds as agents of their shareholders to try and get the greatest possible return for their investment? Wouldn’t any less be extremely unethical with respect to the people with IRAs, 401(k)s and other investments in these funds? If the rule of law entitles these investors to their returns (unless you find this to be a perfect oppurtunity to start retroactively tinkering with US law) then they should get nothing. And if that means the Unions which have spent decades suckling at the teet of the american consumer through higher prices and inferior products for higher wages and lavish retirement bennefits don’t get a red cent . . . so be it.

Posted by Theodore M. Lopez | Report as abusive

sure, the bondholders had a right to stall, and to not accept the offer from the government. Most bankruptcies wouldn’t include an offer from the government to buy the debt at any discount, they creditors would be left to the whims of the bankruptcy judge. The government is only willing to put up money to prevent the loss of so many jobs.

The holdout bondholders believed that they would get more than $2.25B from a bankruptcy proceeding. They, like many of their brethren creditors on Wall St during this decade, are delusional. A liquidation of Chrysler, given that auto sales have fallen off the cliff, would not yield a whole lot of cash (factories that pump out unwanted cars are not worth much, nor is the intellectual property that defines those cars), and what cash that would be generated would go to lawyers and employees (who get paid first before creditors).

The government was not going to give Chrysler an gift so that it can continue to lose billions of dollars each year. Any aid it provided had to be coupled with restructuring of debt, otherwise it would be just pouring money down the sink. the bondholders who held out for more had absolutely no leverage – it was either take the deal or take their chances with bankruptcy. Those chose poorly, and I’m glad.

Posted by KenG | Report as abusive

The financiers are used to being the 800 pound gorilla in every business negotiation and they’re having difficulty adjusting to the fact that there is now a 5 ton gorilla on the block.

By dint of offering DIP financing bankers controlled restructuring, pushing management to undervalue workers, dumping pensions on the government (i.e. socializing losses), etc. They’re having difficulty adjusting to the new world order.

Now it’s the government that has the DIP financing and since it bears the costs of socialized losses and the desperate unemployed, its priorities — and thus the pressures on management — are completely different. Listen to those financiers squeal about the unfairness of it all.

Biggest mistake was giving a penny to these companies without insisting that it be senior to all other debt.

Posted by Anonymous | Report as abusive

One always expects tired arguments but the bondholders in this matter were strikingly stupid. Bankruptcy is a negotiation, both before and after, so sure they had a “right” to hold out for more but the decision was strategically and tactically dumb. Rational investors did not believe a bankruptcy court would liquidate Chrysler or that the court would let these bondholders cherrypick assets for sale, certainly not with the bargaining weight of the government, the unions, a foreign car maker investor and hordes of other lien holders all against them. These guys overplayed their hand and now they’re going to lose because of that.

In the realm of tired arguments, I note a Harvard prof advanced in the NYT the sub-rational argument that if NYC raises taxes the rich may flee. Putting aside that NYC competes for business in more ways than the tax cost of living there, the professor was too busy carrying water for the financial industry to note that NYC is clearly undertaxing its rich if they are found in such great numbers there, and that NYC could raise taxes to a level where it could actually determine whether business was leaving and thus maximize the city’s tax revenue. Who says a city is required to raise less revenue than it otherwise might? Taxes are merely another pricing game and by this professor’s own not-very-good logic NYC is not pricing high enough to extract maximum value. Instead we get this tired old “may” have an effect garbage.

Posted by jonathan | Report as abusive

“The holdout bondholders believed that they would get more than $2.25B from a bankruptcy proceeding”. This is incorrect as the banks have accepted approx. 70% of this offer. The holdout bondholders are holding out for more than $6-700 million offered to them

Posted by Mark Stoneweapon | Report as abusive

what a country when idiots can give all kinds of reasons why the union should get a better deal than people that are legally senior to them. well, that’s the country we live in now that mr teleprompter was elected and anyone that thinks we won’t pay the price going forward for this type of idiocy is, well, and idiot.

Posted by yo | Report as abusive

Well, Felix, we know where you stand. Personally, I am dubious about the whole proposition that the political establishment can willy-nilly tear up contracts outside of bankruptcy courts (where the rules are fairly well established) because the political bully-boys of the day want to make sure that their favorite interest groups are well fed. The Bush/Obama ad hoc approach to who wins and who loses has worn thin. I personally have little taste for expropriating the secured debt holders, and I am surprised that some unsecured creditors are more worthy than others, but I thought that the bankruptcy court would sort that out. The President of the United States has no special wisdom here–he is just another grasping politician who wants to pay off a favored interest group. I am gratified that this is going through the bankruptcy court where all parties in interest will get a hearing. AIG and Bear Stearns should have been there, too.

Posted by Amadeus 48 | Report as abusive

Why should the senior lenders be forced to fund Obama’s payoff to the UAW?

Why should their dubious investment intent (by your standards) trump the terms of their bonds?

Posted by ddbb | Report as abusive

I realize that all members of the UAW (and especially the retirees) are filthy, uneducated swine.

Frankly, their low social status is indicated by how the law did little to require that Chrysler actually allocate funds to fulfill its promises that they would have lifetime pensions and health care, and the low priority those unfunded promises have in bankruptcy.

But Felix is absolutely right – you go into bankruptcy court, rather than negotiate your best deal on the courthouse steps, and all bets are off! Especially considering the high value of Michigan industrial real estate and the incredibly sophisticaed machinery needed to assemble a Dodge Monaco.

Looks to me like these hedge fund wizards might have a Fiat in their future. They may get the 2, but the 20 isn’t going to be worth much…..

Posted by DollarEd | Report as abusive

“The “hedge funds represent normal people too” argument is so vacuous it’s not really worth responding to”

Who cares whether you have money or not. We have laws and they must be followed. Do you seriously think the Obama administration has more experience dealing with bankruptcy than a bankruptcy judge? There is a reason we them, its their job.

“If the current plan is pushed through, then good luck to any unionized firm trying to raise secured debt on decent terms in the future.”

You lost me when you made fun of this. If laws can be changed at whim you will see a huge contraction in economic activity. The basis of the American economy was stability and law. Who would enter into any contract if they thought the government would come in and change it for the “benefit of the people”? I trust the systems we have in place much more than your enlightened opinion of what we should do.

And where is your liquidation talk coming from? If liquidation will result in less value for all the stakeholders than it will not happen so your argument makes no sense.

And you think the government should have a stake in the firm? Are you mad? They gave money to a bankrupt company and knew it. That is called stupidity. The money is gone.

Posted by Mark | Report as abusive

With respect, catfish, I fail to see the Union’s STANDING in any Banko. Employees seldom get taken care of; does having a large and corrupt (criminal) entity entitle them to special and EXTRALEGAL consideration? Creditors take precedence, it is a fact of life. If Chrysler has assets (the Fed’s 4 Billion comes to mind,) they are fair game to a certified and contractual list in Banko. Obama is a dangerous man, interfering as he is, in a conspiratorial way, with both Judicial and Legislative Domain.

Posted by Will Fraser | Report as abusive

“We have laws and they must be followed.”

And they will be. A judge will hear the bankruptcy. The bellyaching from the hedge funds is actually that the law is being followed – just they don’t like it.

Posted by a | Report as abusive

This is a nonsense article. I hope it was written in jest because it’s poor economic thinking……or worse socialistic (Hugo) thinking. Whatever……it’s nonsense

Posted by Hondo | Report as abusive

As an institutional investor I wouldn’t lend these nuts a dime and I certainly wouldn’t buy a car from them.

Posted by Hondo | Report as abusive

You cannot change the rules in the middle of the game like this. That only invites complete anarchy, screws up the entire future of economic planning, and you end up with a banana republic. Good God, you are an economic illiterate.

Who with any sense is ever going to loan companies with strong unions any monet, except at very high rates of interest? Except for the taxpayers, I mean.

Megan McArdle has ripped you a new one. Go read and learn. Idiot.

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