How stealing Chrysler

By Vitaliy N. Katsenelson
On May 1, the United States took a drastic step toward
becoming Russia. Not Russia at its best, not the
motherland of Dostoevsky, Tolstoy, Rachmaninoff…
Instead, Russia at its worst, the one that in 1917 took
from the bourgeois and gave to the working class; the
one that signed contracts with western oil companies in
the 1990s when oil prices were low and then — in 2007
when oil prices skyrocketed – blatantly and unilaterally
“renegotiated” those contracts.
Wielding the public’s empathy as a weapon, President
Obama took Chrysler from its rightful owners: secured
loan holders (a.k.a. TARP-tainted banks, the “evil”
hedge funds, faceless pension funds). And he gave it
to struggling, very sympathetic, $40-an-hour earning
(including benefits, this is not a typo), blue collar
workers — Chrysler’s employees and the United Auto
Workers union. Chrysler, simply, was stolen from its
rightful owners.
Fixed-income investors spend an enormous amount of
time studying bond covenants, which spell out how
assets are disbursed in the event of a bankruptcy.
Secured senior lenders have dibs on the secured
assets; unsecured, junior bondholders and loanholders
follow (as a part of leveraged buyout Chrysler
had no unsecured outstanding bonds or loans); unions
and employees are next in line; and equity investors
get whatever is left, which in this case would be almost
nothing.
The White House fish-fry
For two hundred years our country has had a well
functioning bankruptcy-court system that was designed
to make sure that division of assets is equitable. Now
that system is threatened.
The banks, the ones that received billions of Federal
funds, were forced to give up their legal ownership
first. Were they told they would fail the recent stress
tests (which they recently passed) if they didn’t give up
their rights? Or maybe their CEOs were told they’ll be
fired if they did not go along? These days you don’t
have to be a conspiracy theorist to make these
accusations. After all, then-Treasury Secretary Hank
Paulson and Federal Reserve Chairman Benjamin
Bernanke used the latter tactic to get Ken Lewis, CEO
of Bank of America, to lie to his board and
shareholders about the purchase of imploding Merrill
Lynch. We may never know what happened, but I’ll
promise you this — banks did not walk away from
billions of dollars of the desperately needed money, not
at their own will.
After the big fish were fried, President Obama went
after smaller loan-holders — he called these hedge
funds and pension funds “speculators” — who put up a
fight. Those institutions were not tainted by TARP
money, thus the president had to use populist rhetoric,
saying that they “endanger Chrysler’s future by
refusing to sacrifice like everyone else.” He
turned public opinion against the loan-holders, whose
only fault was that they financed the dysfunctional
automotive sector for too long and maintained fiduciary
duty to their investors by attempting to collect what was
legally due.
President Obama is popular and hedge funds are not.
Thus as the financial and political costs became too
high, these smaller fish jumped into frying pan with the
banks. The fact that these pension funds and hedge
funds invest money for regular folks like you and me is
ignored. Average Joes aren’t paying close enough
attention to catch that little detail; and unlike the UAW,
they did not bankroll Mr. Obama’s campaign.
Losing the empathy contest
The consequences of what took place May 1 are not
immediately apparent, but there are consequences.
Forget about right or wrong, forget about politics: If any
other President had done what Mr. Obama did you
would have been reading the same thoughts from me.
The rule of law, the bedrock of our system was chipped
last week. Instead of company ownership being
redistributed based on the provider’s place in the
capital structure — as the law requires — the asset
redistribution took place based on a very subjective
criterion, empathy. Banks, hedge funds and pension
plans don’t win empathy contests these days,
especially when competing with down-and-out workers.
President Obama’s actions will have a twofold impact:
• First — and this is certain — they impaired auto
companies’ ability to borrow from the fixed
income market for at least a generation, and
that’s regardless of whether they have secured
collateral.
A fixed-income investor, when pricing a
security, makes certain assumptions of
recovery based on the collateral and its place
in the capital structure in the event of
bankruptcy. The better the collateral and the
closer it is to the front of the capital structure,
the less money they stand to lose, and thus
the lower the interest rate they expect to
receive. In the case of Chrysler, loan holders
expected to recover around 70-80 cents on the
dollar if the letter of law was followed. After the
company was given away to UAW, however,
that number dropped to 29 cents.
Would you buy an auto company’s bonds in
your retirement account if you knew that this
industry often flirts with death, the rule of law is
suspended and empathetic workers take your
money if/when things go wrong?
• The second impact is more significant to the
US economy, but will depend on future
government actions. If the empathetic
distribution of wealth stops with the auto
industry, investors may look at it as a one-off
deal, specific to the dysfunctional auto
industry. But if Mr. Obama repeats this even
once outside of the auto industry — and he’ll
have plenty of chances as we are in a
prolonged recession — the political risk of the
US will increase. Lenders, be it bond or loan
holders, will lower recovery assumptions for
even very secured assets, and the risk
premium and thus borrowing costs will rise for
all companies.
Empathy is an honorable emotion, we feel bad for
people losing jobs, but changing the rules, in this case
the law, in the middle of the game in most developed
countries would be considered criminal, shortsighted
and not good for the system. If you don’t trust the
rules, you cannot play the game. I hope our president
stops while he is behind.
Vitaliy N. Katsenelson, CFA, is director of research at Investment
Management Associates in Denver, Colo., and he teaches a
graduate investment class at the University of Colorado at
Denver. He is the author of “Active Value Investing: Making
Money in RangeBound
Markets” (Wiley).

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categories Currency, Fixed Income/Bonds, Politics, Strategy/Allocation | | datetime May 13, 2009 8:24 am

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