Chrysler Bankruptcy and Demagoguery

Some of Chrysler's creditors rightfully objected to bankruptcy plan that gave most of the company to holders of unsecured claims (the UAW) above the secured debt holders. The bankruptcy code calls for absolute priority in any Chapter 11 reorganization. In the case of Chrysler, this means that the senior secured creditors must receive at least what they would have received in liquidation before anyone else is paid. The art and science of valuation plays a key role in determining the estimated liquidation value and the value of the non-cash settlements distributed to claimants.

Politicians have used the Chrysler bankruptcy for demagoguery and seek to bypass the usual legal processes. Michigan Congressman John Dingell stated, "the rogue hedge funds that refused to agree to a fair offer to exchange debt for cash from the U.S. Treasury – firms I label as the “vultures” – will now be dealt with accordingly in court." The governor of Michigan said, "It also came in spite of a few greedy hedge funds that didn't care how much pain the company's failure would have inflicted on families and communities everywhere. Their refusal to share in the sacrifice forced bankruptcy proceedings to begin." Finally, Obama said that they were "a small group of speculators" who "endanger Chrysler's future by refusing to sacrifice like everyone else."

Ultimately, a bankruptcy that violates absolute priority based on political pressure sets a bad precedent on a couple of levels. First, it is damaging to the rule of law. The bankruptcy codes and precedents are well-established. While there are technical issues in valuation, the spirit of absolute priority is the central issue. The dissident claim holders in the form of the non-TARP lenders had every right to demand their fair share. Politicians have no right to demand that secured lenders sacrifice so that the UAW or anyone else could get a better deal. It does not matter at all that these creditors were "rogue" hedge funds or that many did not pay face value for their claims -- the rules of the game are already set for this bankruptcy. To blame "speculators" and hedge funds is nothing less than classic demagoguery. Second, the consequences in the capital markets may be far-reaching. How will debt be priced if security is meaningless in practice and determined by your favor with politicians? It is similar to the cram-downs on mortgages. It sounds like a way fix the housing markets in areas where many are under water on their mortgages, but it would be difficult to expect that mortgage rates in the long-term.

Some defend the "speculators" because of they are pension funds representing ordinary workers.

Far from being speculators, these funds represent retired public employees, including cops and teachers. The funds paid a premium to buy "secured" status, only to discover that they were politically outranked by the United Auto Workers in the White House hierarchy.
WSJ 5/21/09

This is a true statement since the financial markets affect wealth far more than direct holdings indicate. However, this cannot be the major point of the defense. It does not matter whether the claim holder is a "rogue hedge fund" or a fund for widows and orphans--the bankruptcy courts are not a place or charity. To do anything other than follow absolute priority is to ignore rule of law.

The Yield Curve is Getting Steeper

The term structure of interest rates (the yield curve) has historically been a leading indicator of economic indicator. Over the last few months, the yield curve has become much steeper. The December lows on the 30 year was 2.52% with the 3 month at basically 0. Since then the 3 month has moved up, but not by much while the 30 year has soared to over 4%. A steeper yield curve is a good sign for economy. It indicates that there will be higher interest rates due to more demand for capital. The yield curve has typically been a good indicator, but one has to wonder if the same rules apply in this situation.

MSNBC is typically a waste land, but...

Rachel Maddow on MSNBC delivered a scathing critique of a recent Obama speech. Obama criticized Bush policies on detainees, and then in the same speech he claimed the authority to do the same things as Bush. I do not watch her show, and I would probably disagree with most of her policy stands. However, she gains some credibility by applying the same standard to her guy as Bush.

http://www.youtube.com/watch?v=1uuWVHT1WUY

Social Security and Medicare

I am currently taking a financial statement analysis course, which covers a number of accounting issues that have wider implications in the economy. The adjustments to property, plant, and equipment, leases, inventories, and pensions are made by financial analysts to get closer to economic reality and the prospects of a company. With current payroll taxes and benefit schedules, there is a substantial unfunded liability that is not included in the national debt. If believe the numbers, either taxes need to go up or benefits must be reduced.

The early recipients of social security received much more than they paid into the system. When there was a huge number of works for every retiree, there was no problem with this model. However, the population is aging and fewer workers support each retiree. The excess paid to early recipients will catch up with us, and somebody has to pay in reduced benefits or increased taxes.

Under GAAP standards, the obligations of the federal government are several times the official national debt. While I'm not in the business of predicting a collapse, I have to wonder who is going to buy the bonds of such a leveraged country going forward.

A Problem Made For Bankruptcy

There is a set of laws already in place to deal with GM's bondholders, suppliers, unions, and anybody else who has a claim on the company's assets. The bonds are widely held, there are many suppliers and other obligations. In order to get all of these constituencies to the table, the bankruptcy court is the best way to settle it. The court would follow established precedent and priorities to pay out claims or reorganize the company rather than a popularity contest playing to political concerns. A successful bankruptcy reorganization will result in:

1. Creditors paid in a fair and equitable settlement in accordance with absolute priority. The ones that will make "sacrifices" will always be the ones with lower claims.
2. GM going forward with a less burdensome debt enabling the company to compete better with other automakers.

Bankruptcy allows the creditor classes to vote(1/2 in number and 2/3 in amount) on a plan that is binding to all parties, effectively solving the holdout problem. Even if a class holds out, a bankruptcy plan be crammed down.

Chapter 11 was designed to force all the claim holders together and giving nobody what they want. That's what GM needs to move on.

Trillion with a T

The national debt is increasing at a rate of over $3 billion per day. From the lows of December 18th, the 10-year and 30-year Treasury bills have risen substantially. December was a panic flight to quality that pushed the 30-year yield to 2.55%. It rose to 3.80% as the panic subsided and investors realized the supply of Treasuries in the next several years will be enormous. The Fed stepped in saying it would buy longer term treasuries which brought yields down sharply. This steep fall in yields was not sustained in the next few days. I believe that much of this is due to concern about the future rate of inflation. If the Fed sustains it's buying for too long, it will fuel inflation. China is talking about scaling back its purchases of US Treasuries. I am sure others will not be far behind.

AIG Bonuses

With the handing out of $165 million worth of bonuses to AIG executives, some are upset. In large part the reaction to this is on pure emotion and the remedy disregards respect for due process. The anger directed at Edward Liddy, the CEO of AIG, is downright absurd. He joined AIG after the disaster in the credit default market, taking a salary of $1 and compensation in equity. If there's no value left in the company, Liddy will not profit.

Only a part of AIG was part of the mess that resulted in a government bailout. AIG lost huge sums of money on credit default swaps that they wrote. Many of AIG's business units are profitable, and there is no reason why the executives that lead those businesses shouldn't receive bonuses. Since AIG is planning to sell some of its business units, it would be very unwise to push their leaders out and sell a business that is in shambles. Such a policy punishes those that had nothing to do with AIG's failures. If we still believe AIG is an investment for the government, this policy destroys the value of the investment.

The bonuses as a percentage of the bailout money received are a very small part of the total. The bonuses in question are $165 million compared to the bailout of at least $90 billion, perhaps more by now. The federal government is running a deficit of $1.7 trillion. Even if the bonuses are completely undeserved, this is no reason to invalidate contracts and throw out the rule of law.

The bill passed by the House to tax the AIG bonuses at 90% is a clear violation of the spirit of the Constitution. I am not a Constitutional scholar by any means, but this is a clear example of a bill of attainder. The text of the bill does not explicitly single out AIG or this group of executives, but the intent is clear from the words that Congressmen use.

"Our message is clear: If you won't give the bonuses back, we will tax them back," Rep. Steve Israel, D-N.Y., said at a Wednesday press conference to announce the legislation.

Taxing these bonuses at 90% reduces us to mob rule.(Should we not consider this confiscation just because they get to keep 10%). The intent of this bill is to:

1. Punish by taxing at a 90% rate
   
2. Single out a specific group of individuals
3. Impair private contract

My guess is that many of the same people that oppose Guantanamo Bay are in favor of this bill of attainder. Where is the ACLU on this one?