David R. Henderson  

Zywicki on Chrysler

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In today's Wall Street Journal, Todd Zywicki lays out how President Obama attacked holders of Chrysler debt. A key paragraph:

The Obama administration's behavior in the Chrysler bankruptcy is a profound challenge to the rule of law. Secured creditors -- entitled to first priority payment under the "absolute priority rule" -- have been browbeaten by an American president into accepting only 30 cents on the dollar of their claims. Meanwhile, the United Auto Workers union, holding junior creditor claims, will get about 50 cents on the dollar.

Zywicki reminds us of unintended consequences, "what is not seen:"

By stepping over the bright line between the rule of law and the arbitrary behavior of men, President Obama may have created a thousand new failing businesses. That is, businesses that might have received financing before but that now will not, since lenders face the potential of future government confiscation. In other words, Mr. Obama may have helped save the jobs of thousands of union workers whose dues, in part, engineered his election. But what about the untold number of job losses in the future caused by trampling the sanctity of contracts today?

Zywicki, by the way, wrote the article on bankruptcy in The Concise Encyclopedia of Economics.


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CATEGORIES: Finance



COMMENTS (7 to date)
RL writes:

Richard Epstein via Reason.com had similar comments:

http://reason.com/blog/show/133436.html

Troy Camplin writes:

Nice to see someone other than myself, over on my lonely blog, observing that Obama has been systematically ignoring rule of law.

rpl writes:

David,

One of the things that has confused me about the Chrysler deal is the claim that even at 30 cents on the dollar the Chrysler bondholders got more than they could have expected in bankruptcy court. The argument seems to be that the provider of the DIP financing can set up whatever kind of deal it wants, and the firm's creditors can either take the deal or leave it, opting instead to get what they can in bankruptcy.

Is any of that true? Is 30 cents on the dollar actually more than the bondholders could have expected in liquidation? Is the provider of DIP financing really free to ignore the creditors' pecking order when it puts together a deal? The question of whether the Chrysler deal respects the rule of law seems impossible to evaluate without knowing the answers to these questions. Can you offer any insight for those of us not well-versed in bankruptcy procedures?

Troy Camplin writes:

Actually, the answers to those questions doesn't have anything to do with the rule of law. It may in fact be true that if rule of law were followed that the bondholders would have gotten less -- but it is also true that the unions wouldn't have fared any better than the other bondholders. Instead, what we see here is Obama clearly granting privileges to one group over the other. That violates rule of law. Whatever would have happened under bankruptcy proceedings is what would have followed rule of law, and even if the other bondholders made out better than they would have under bankruptcy, it was Obama's commands that made it so, and thus rule of law was violated.

rpl writes:

Troy,

You are ignoring the possibility that the law provides for creditors to agree on an alternative to bankruptcy, if it is in their interest to do so. Proponents of the Chrysler deal claim that they do, and that as the provider of the financing to make the deal happen the administration has some discretion about how that deal will be structured. What I am asking is whether it is in fact true that the law provides for an alternative to bankruptcy, if the creditors consent to it.

marc writes:

I have a ton of respect for Profs Zywicki and Epstein but believe they are both wrong in this instance.

1) The secured creditors here do not hold individual interests in the collateral. They share in a single mortgage held by the lead bank. That is controlled by majority vote according to all the case law. Thus, the rule of law is indeed being applied to the minority.

2) The debtor is burning thru cash daily. It has relationships with lots of private creditors and bankruptcy experts but can't raise enough money from them either to stay out of bankruptcy or to reorganize to positive cash flow in a traditional bankruptcy. This is a common situation in American business and a liquidation sale is a common resolution.

3) It looks like the net present value of 2 billion is, risk-adjusted, no worse than the alternatives (long uncertain liquidation or funding billions of losses) to the majority of secured creditors.

4) I recommend Prof Mark Roe's writeup on Forbes.com as the best analysis of this situation.

5) this is not an unprecedented action. In the 60s and 70s, the federal govt did something very similar in the railroad bankruptcies of the railroads on the East Coast and created Conrail and Amtrak.

diz writes:

In general, I think the reportage on this settlement has been terrible. Important details are being completely missed and/or misunderstood.

I can't figure out where this tagline that "the secured creditors received 30 cents on the dollar while the unions received 50 cents on the dollar" comes from.

It appears that the secured creditors received [b]cash[/b} of $2 billion in exchange for claims of $6.8 billion.

The "unions" do not appear to have received anything directly, however a VEBA that benefits Chrysler retirees will receive a $4.6 billion note payable and 55% of the New Chrysler stock.

http://www.whitehouse.gov/the_press_office/Obama-Administration-Auto-Restructuring-Initiative/

So, it does appear the claim that secured creditors received 30 cents on the dollar is true. Whether this is more or less than they could have expected to get in a liquidation, I have no idea. My bias is that without the prospect of government bailout, all debtholder claims on Chrysler would have been worth close to zero. Chryler is a cash destroying monster. The question would be can enough assets be sold fast enough to outrun the cash burn rate. Maybe.

I can't figure out where the "unions received 50 cents on the dollar for union claims" comes from. I hope it is not as facile as equating the 55% of the New Company stock they got to 55 cents on the dollar. Annyway, I don't know what their previous claims were (perhaps the $4.6 billion note payable they recieved is a roll over of their old claims?), but 55% of the new company may be worth something close to zero or it may be worth a lot. I'd bet more on something close to zero. If they don't fix the cash flow burn, there will be Bankruptcy Round II coming soon enough.

Anyway, from my perspective as an equity deal maker, the obvious big loser here is the taxpayer. They put in more than enough money to buy all of the exsiting debt and equity claims many times over, and walked away with 8% of the equity. If I were going to put my firms money up to recapitalize this mess (which I would not even consider without some immediate union concessions/other steps to halt the cash burn) I would expect to own 100%.

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