Felix Salmon

Joe Weisenthal is upset that the UAW seems to be getting the upper hand over hedge funds and vulture investors:

If we’re thinking about the future, we’d much rather ensure that the notion of bondholder seniority and the rule of law is preserved rather than ensuring that institutions of industrial workers known as unions are preserved.

I could go on at some length about how unions really are necessary to the continued survival of the Detroit auto industry, even if they haven’t been used at Japanese-owned car factories in southern states. But really it’s easier to just quote TED:

Here’s a clue for the novices in the room: It’s called politics, you fucking morons. Stop being such a bunch of whiny pansies.

The holdouts didn’t sway the Obama administration, and it doesn’t look like they’re going to have much more luck in bankruptcy court, either: holders of fully 90% of Chrysler’s bonds are now on board with the government’s deal. It’s over. You lost. Move on.

Joe Weisenthal asks a how I can believe that bankruptcy is a good thing for Chrysler, and yet at the same time rail against the very hedge funds which drove Chrysler into bankruptcy. Quite easily, is the answer, so long as the creditors don’t get what they’re looking for out of the bankruptcy process. And although it’s very early days yet, I do have faith that the bankruptcy court will tell the creditors to take a hike if they try to demand much more than what the Obama administration was offering them.

The key thing to note is that the government already has the biggest senior creditors — the big banks — on its side. Which means that getting a supermajority of bondholders to agree to force the hold-outs to take the government’s offer might not be too difficult. Bloomberg explains:

Chrysler’s dissident lenders have on their side the “absolute priority” bankruptcy rule, which holds that value must be distributed according to the legal priorities of the stakeholders…

The absolute priority rule is regularly modified in bankruptcy court, said Richard Hahn, co-chairman of the bankruptcy practice at Debevoise & Plimpton LLP, a New York law firm that isn’t involved in the Chrysler negotiations. Two- thirds of the lenders can force the holdouts to go along with them in a procedure called a cram-down.

“The U.S. bankruptcy code foresees the possibility that it may be necessary to vary from absolute priority, in particular when a two-thirds majority is convinced it makes legal or business sense,” Hahn said. “If the government has consents from 70 percent, that’s more than enough” to give equity to junior creditors.

(Thanks to Nate for the pointer to the article.)

As for bankruptcy, most of the downside has already happened, with the firm’s sales down a whopping 48% in April. And Chrysler’s CEO, for one, has very much changed his tune on that issue:

BARTIROMO: Bob, the last time we spoke, you said to me, `Look, it’s a death knell if we go bankrupt because nobody is going to buy a car from a bankrupt company.’ Now you’re filing Chapter 11. What’s changed?

Mr. NARDELLI: Well, let me say this, Maria. Boy, I tell you, if I was ever wrong about something, I’m tickled to death I was wrong about that.

Of course, there’s probably a sense in which Nardelli has to say this. But still. I think this issue has been batted around the media enough by now that Americans are aware of the government warranty backstop, they’re aware that bankruptcy doesn’t mean the same thing as going out of business, and they’re even aware that if you buy a Chrysler going forwards, you’re going to be buying a car from a company 55% owned by its own workers. So the optics of bankruptcy are improving, it gives the company lots of much-needed flexibility on the dealership front, and it’s unlikely that the hold-out creditors will get what they want. So thank you, hedge funds, for forcing this move. I hope — and believe — you won’t get what you want out of it.

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.

It’s surely a good thing that Chrysler is filing for bankruptcy: trying to get unanimous consent for a restructuring from dozens of stakeholders — especially small bondholders — was never going to happen on a foreshortened timetable, and it’s going to be much easier for Chrysler to get out of onerous obligations to dealers when a bankrupcy judge orders it. At the same time, the downside of bankruptcy — the fact that the public will be increasingly unsure about the company’s future — is here already; it’s unlikely to get worse, especially so long as Barack Obama makes it very clear that he’s committed to Chrysler’s continued existence as a going concern.

The broad outlines of a deal are already clear: Fiat will take a 35% stake in the company and manage it; the UAW will have a 55% stake; and all the government’s TARP funds will be converted into a 10% stake. Present-day creditors do not get equity but rather get cash; the sticking point is exactly how much cash they will get. And of course present-day shareholders — Cerberus and Daimler — are wiped out, and top management will be replaced.

All of this is necessary but not sufficient for Chrysler to have any hope of a long-term future. One of the more interesting things going forward will be how Chrysler manages to turn itself into a smaller, nimbler, change-oriented company while being majority owned by the UAW — which is nobody’s idea of a change agent. In general, if you need a dose of creative destruction, big unions are not the place to look.

On the other hand, it’s not as though anybody else has been able to manage Chrysler any better, and now, by definition, workers’ interests are aligned with the owners’ interests, just because the workers are the owners. Given how everything up to now has failed, this structure is at the very least worth a try.

As for the smaller creditors who stood in the way of a deal which would have avoided bankruptcy, I have very little time for their plaints. They’re offering nothing which will help Chrysler in the future: they just want to get the maximum return on selling the bonds they picked up for pennies on the dollar. I hope and trust that the bankruptcy judge will give them short shrift.