Tuesday, May 5, 2009

Chrysler Bankruptcy To Set Precedents

As boring as it may seem to wade through the legalese lingo involved, the proceedings over the Chrysler bankruptcy are extremely interesting. However, the issue at hand is not so much to do with Chrysler itself, but rather the precedent setting effects the rulings will have for other soon to be bankrupted companies over the next few years.

The ruling will have broad implications for the equity and corporate bond markets, as previously assumed claims to assets may be juggled in favor of populist politicking. But I would also argue that this case has implications for the US in general, as the sanctity of contract law takes a backseat. One of the defining characteristics of a modern economy in comparison with a banana republic are its adherence to contract laws and guarantees of private property.

That is what is at stake here.

Steve Jakubowski does a great job on his blog in outlining the details of this and some of the previous precedent setting cases that will be contributing to this present day situation.

Chrysler is owned by a variety of different classes of investors, all of whom have different places in line in terms of priority in the event of a liquidation. Those who are at the bottom of this structure are obviously trying to prevent liquidation altogether and instead push for a type of reorganization in which they would still have a claim if the company were to ever recover. Those who are at the top of the structure are trying to push a full-scale liquidation through as fast as possible in order to protect the value of the assets that are rapidly losing value as time wears on (things like the R&D department or the brand name). There are also the employees and suppliers in the middle of all this, fighting for their pensions and accounts receivables that Chrysler owes them. And let's not forget the US Treasury who took a stake in the company a few months ago.

The Obama Administration is using its clout in the process to demand a higher payout to the unionized workers and for itself than they should otherwise be entitled to. This is obviously upsetting the senior secured lenders and others who are higher up in the capital structure but are being brushed aside for political purposes.

As mentioned before, it is the sanctity of contract law that is of issue here. If this is allowed to occur, there could be a stampede out of senior corporate debt for fear of not being honored in bankruptcy court to their rightful claims. The subsequent rise in the cost of obtaining financing in such an environment would have the additional effect of expediting their own bankruptcies.

What makes this seem acceptable to many is that in most cases the senior preferred holders are hedge funds - not exactly the most popular bunch right now. As much as it may seem appropriate to stick it to these overpaid, greedy and often incompetent elite class, it should be remembered that "two wrongs does not make a right." If the individual fund managers, bankers and the like can be found guilty of fraud, then they should be convicted of it and put in prison where they belong. Putting political pressure on them via selective enforcement of contract laws could have very grave long-term consequences for the international perception of safety in the US markets.

It should also be remembered that in many cases, investors in hedge funds are pension funds themselves. So in order to satisfy the demands of the auto unions' pensions being spared, the Administration is indirectly punishing other pensioners. Such political favoritism could prove damaging in the long-term.

Contracts and the rule of law need to be upheld. The loss of confidence that could result from selective enforcement of laws could further cripple the already shaky corporate bond market and accelerate a crisis in pension funds.

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mike.montchalin said...

Nice post.

Just the thought that there are people out there who are arguing the violatility of contracts leaves me in shock.

RRB said...

I cannot believe this will pass. There has to be a judicial stop to this nonsense. The very sanctity of contracts is at stake - I cannot believe this isn't the biggest news story out there.

Matt Stiles said...

To be clear, I don't think it will pass either. But it is probably not an all or nothing type thing. The judge will likely give in to a little of the pressure but not all. The next judge will use that as precedent to go a little further. It will be incrementalized.

RRB - Your comment "I cannot believe this isn't the biggest news story out there," rings very true. Anytime there is a geopolitical "scare," it is usually a good bet to look at the second or third headline. They are typically where the real action is.

mannfm11 said...

I got banned from the former Prudent Bear board using some pretty strong language to describe the Obama administration (I think I compared his actions to Hitler in how Hitler took over the German economy and defaulted on the international debt)in this matter. These are lawless people and if they continue to run the US economy in this fashion, we will see capital flight from the US to a degree that I believe will create a worldwide collapse. It seems that few in the US can grasp what is going on and since most have their hands out, we are unlikely to be able to defend the country from such lawlessness should the courts fail. BTW, I wrote a mainstreet readable post on my blog.

occdude said...

The solution is simple. The senior secured bond holders need to get the supreme court involved. I mean, is any of this crap legal? Bailouts, bank equity stakes by the government all manner of interventions, where does it outline these actions in the constitution?

The third branch of government has been noticeably quiet through this whole economic event and their job is to define the limitations and actions authorized of the government by the constitution and I'm getting somewhat angry that our system of checks and balances aren't working. Someone or multiple ones need to push this legally.

The supreme court was what stopped Roosevelt from his more disasterous inteventions (until he got his "boys" nominated) yet now their silence is deafening.

Before Obama and CO. can stack the supreme court with loyalists, these interested parties in the Chrysler situation should press their case and check these SOBs to make them think twice about running ramshod over the laws and contracts of this country.

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