My colleague Todd Zywicki has a must read op-ed in the WSJ. Here’s an excerpt:
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.
The absolute priority rule is a linchpin of bankruptcy law. By preserving the substantive property and contract rights of creditors, it ensures that bankruptcy is used primarily as a procedural mechanism for the efficient resolution of financial distress. Chapter 11 promotes economic efficiency by reorganizing viable but financially distressed firms, i.e., firms that are worth more alive than dead.
Violating absolute priority undermines this commitment by introducing questions of redistribution into the process. It enables the rights of senior creditors to be plundered in order to benefit the rights of junior creditors.
Go read the whole thing.
Asness is full of baloney — he put his money into high-risk investment which predictably exploded and which would return far below 0.30 if the government wasn’t involved. If he had someone lined up willing to say, “yes, I can repay better than the government can,” I’d be willing to listen. As is, he’s just grandstanding to get more than 0.30 from taxpayers for his failed investment.
The point about “whose money is it anyway” is relevant, but it ignores the central issue here: in a free market, this company would be liquidated for far below 0.30. I’m not going to listen to anyone complain about “unfairness” when the government is stepping in to give them money, far more than the free market would.
But even in this unusual context, Obama’s plan isn’t that unusual. Were I buying a company, I’d torpedo the senior creditors — who have NO interest in the future of the company and are purely deadweight — in favor of the union, which has an interest in the future of the company and an incentive to make it profitable again. Indeed, the unions have ample groups to complain that the deal is unfair to them.
I think Max and Thom both make good points, but it’s instructive that neither post provides support for Zywicki’s “rule of law” point. It’s not like the Administration is overruling the bankruptcy judge. One may have issues with the U.S. acting like a sovereign wealth fund and using its money for policy goals. (By the way, I think the policy goal here is not “payoff to the union” but rather “best chance of ongoing viability.”) One may argue that the Administration is violating the rules of capitalism. But is it not “a profound challenge to the rule of law,” and the administration is not violating absolute priority. Does Zywicki think the creditors would get a better deal through a liquidation?
There are MASSIVE differences between Max Kennerly’s Buffett hypo and what Obama did with Chrysler.
First, when a private financier makes demands on senior creditors as a condition to providing financing, it does so to ensure that it gets repaid. It says to the senior creditors, “I’ll lend money here if you give up your seniority in my favor so that I get my money back.” Here, the Obama administration said to senior creditors, “You must give up your seniority NOT to me (so that I get repaid my money) but to junior creditors to whom I owe a political debt.” The messing around with the seniority system was not at all designed to guarantee the government’s repayment. It does not make it more likely that the government will be repaid. Instead, it rewards a group to which the President is politically beholden.
A second important difference in the Obama and Buffett scenarios is that Buffett, when he does this sort of thing, is investing HIS OWN MONEY (or money received from investors, to whom he owes a fiduciary duty to maximize gains) in order to make a profit. When the government starts acting as a business player (financier), its goal is not profit maximization, and the decisionmakers are not spending their own (or their investors’) money. The potential for mischief is massive.
IMHO, the best thing out there on this Chrysler disgrace is this letter from hedge fund manager, Clifford Asness, who didn’t take too kindly to the President chiding hedge fund managers for refusing to steal from their clients in order to win our popular President’s favor. Money quotes:
If Obama had jumped as President into an on-going bankruptcy and ordered the senior creditors get trashed more than junior creditors, we’d have a real problem.
That’s not what happened. The US is exercising no more power than it’s entitled to as the financier of the restructuring.
Replace “Obama” with “Buffett” and run these same facts. An insolvent company and its creditors try to engineer a deal with an outside financier, who demands X cuts from senior creditors and Y from junior creditors. It is not at all surprising that the outside financier will try and attack the senior creditors first, since the outside financier wants as senior a claim as possible, and the senior creditors are the primary obstacle both to the outside financier’s priority and the later profitability of the company.
Everyone agrees to the new plan except for a handful of senior creditors, so the company goes into bankruptcy.
The bankruptcy judge then looks carefully at the deal, maybe plays with it a little bit, and then, upon the advice of the Debtor, the Creditors’ Committee (which is run by the same majority of senior creditors), and the U.S. Trustee, and with objections solely from the handful of unhappy senior creditors, orders everyone to adopt the plan, and thereby orders the objecting senior creditors to play along.
That, in a nutshell, is what happened here and what happens in every major bankruptcy. I wonder if Zywicki can name a single major bankruptcy in which the senior creditors fared better than the junior creditors. (Excluding, of course, those situations where the senior creditors themselves provide debtor-in-possession or post-bankruptcy reorganization financing, which is not the case here.)
I wonder how concerned Professors Zywicki and Wright were when they were on the staff at the FTC, an agency that violates the rule of law in just about every way imaginable on a daily basis.