Abrogation of Justice Will Delay Recovery Indefinitely

The sanctity of contract law is being rapidly dismantled in the United States. The same laws that have made doing business in the US more secure than anywhere else in the world for centuries, are being torched in favour of political partisanship.

Never mind the economic interventions, the bailouts and rising deficits. Never mind the future taxes that are sure to crush any attempt at a recovery. Never mind the price fixing that is sure to cause shortages. Never mind all that.

The most important factor in determining whether an entrepreneur should invest in future production is the rule of law. Without the unhindered rights to private property and debtor protection in the event of bankruptcy, there is an enormous risk premium put on entrepreneurial activity.

It is for this reason that third world countries cannot manage to develop into civilized economies despite having plentiful natural resources, cheap pools of labour and often even decent education. It is not worth the risk! Why take all the risks of investing in some new factory or piece of farm machinery in order to improve your yearly productivity by 3-4% if some corrupt judge or politician can willy-nilly take that asset from you without compensation? Why bother? Why not just keep your savings buried in a hole in order to ensure you can feed yourself for the next year?

80% of the world's population lives under such circumstances. America seems determined to join them.

My worst fears were realized in the outcome of the Chrysler bankruptcy. In the name of "expediency," the company was torn away from its rightful owners (the secured creditors) and given to union interests, a foreign company (Fiat of Italy) and the US government themselves. Those who had lent Chrysler money over the last decade with the impression that, should worst come to worst, they would at least have claim to the factories, the brand names, etc, were run roughshod over, given mere pennies on the dollar. These people accepted a lower rate of interest on their loans in order to ensure this priority in the event of bankruptcy. Hundreds of years of judicial history was on their side.

There are many reports of certain secured creditors being threatened if they were to stand in front of the proceedings. Many of the larger bond holders were the same banks that had received money under the TARP programs. They were not given a choice. In a round about way, they were paid off by taxpayers to remain silent and not object. And the remaining few holdouts, like the Indiana State Pension Fund, were publicly vilified and subsequently dismissed by the Supreme Court.

One might be led to believe that because all of the creditors eventually agreed to a settlement, that no wrongdoing was committed. But in most cases, going up against the Administration was going to prove even more costly than simply walking away. The press release from investment firm Perella Weinberg sums up the decision making process:

Suggestions have been made that the Perella Weinberg Partners Xerion Fund changed its stance on the Chrysler restructuring due to pressure from White House officials. This is incorrect. The decision to accept and support the proposed deal was made by the Xerion Fund after reflecting carefully on the statement of the President when announcing Chrysler’s bankruptcy filing. In considering the President’s words and exercising our best investment judgment, we concluded that the risks of potentially severe capital loss that could arise from fighting this in bankruptcy court far outweighed any realistic potential upside.

We have a very specific mandate from our investors, and that is to carefully weigh investment risks and rewards. It is not our investment mandate to pursue political or risky legal campaigns with our investors’ money. This was our assessment of investment risk and reward, nothing else.



While we did and still do believe that the lenders would be justified in pressing their objections under conventional bankruptcy law principles, we believe a settlement would now be in the best interests of all parties in the context of avoiding a drawn out contested bankruptcy litigation proceeding, and we encourage our colleagues in the loan syndicate to pursue this immediately.

And so it was. Cronyism at its finest.

But the secured creditors were not the only ones getting screwed. Anyone with an outstanding claim against the former company is now hung out to dry. This includes family members who were killed due to manufacturing defects, anyone pursuing false advertising claims and things of the like. These claimants have been relieved of their legal recourse. People who purchased a vehicle for a price, reasonably thought to include legal liability should something go wrong, have now been denied.

As outrageous as these specific abrogations of justice are, it is obviously not the specific instances that are of the most concern. It is the fact that once set as precedent, any judge is now required to view the Chrysler case as precedent setting. In order to rule otherwise, defense lawyers need to prove beyond reasonable doubt that their case is different.

More specifically, General Motors, a company many times the size of Chrysler is going through the same process as we speak. Thankfully, there is no bidder for the company's assets that can serve as cause to rubber stamp the process. But the precedent has been set for unions and the government to supersede any other claimants. What about other looming bankruptcies? How will other unions feel if they were not to get favourable treatment like the UAW? How will consumer's decisions be affected by the knowledge that a manufacturing defect could leave them high and dry?

But most importantly, what effect is this going to have on the economy as a whole? As mentioned, it is obvious that investment risk has been heightened greatly. Who in their right mind would lend money to a struggling company that requires retrofitting of their factory to become competitive again? Interest rates for these companies are going to skyrocket.

Investment in productive capacity is what gets an economy out of recession. Higher savings rates drive down interest rates, making investments in the early stages of production easily doable - investments that in the previous boom were too expensive to undertake. The ensuing employment created and increase in productivity from the use of this new capacity increases profits for entrepreneurs and a recovery is born.

The Obama Administration and the US Courts of Justice are foolishly cutting the legs out from this process. They mistakenly believe that the reason for the recession is "underconsumption" rather than a lack of profitability of business in the previous expansion. "If people would just consume at the 'equilibrium rate,'" they cry, "then producers would have no reason to fire workers, thus preventing further 'underconsumption.'"

But here we have the classic mistake in neoclassical economic theory. "Equilibrium" is thought to be something totally unrepresentative of normality. Neoclassical economists have no way of determining what equilibrium looks like, so they foolishly assume that the economy was in equilibrium whenever it appeared to be most beneficial to everyone. But what appeared to be most beneficial was an illusion. Fueled by cheap credit provided by the central bank and overly optimistic lenders, people were overconsuming. Now that the inevitable readjustment is taking place, politicians and central planners are trying to fit a square peg into a round hole - an economy plagued by overconsumption into an economy that cannot produce goods profitably.

The denial of legal recourse to those entitled is making it even more difficult to invest profitably and the social aversion to the superficial is killing the consumption goose.

The Obama Administration is doing their best to prevent these opposing factors from coming into balance. Good luck finding a recovery in this mess.


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