In an odd twist, enough of Chrysler’s creditors voted against the administration’s reorganization & recapitalization plan to force the automaker into bankruptcy. The filing is expected today. Credit default swaps may be playing a supporting role in this drama, as I’ll get to at the bottom…
Yesterday, the reorganization plan seemed close to completion. Four big banks controlling 70% of Chrysler’s debt had signed off on the deal. This isn’t surprising. The four banks in question are Chase, Citi, Morgan Stanley and Goldman Sachs. All are current (and likely future) recipients of bailout money and favorable Fed/FDIC lending facilities so they are willing to do the administration’s bidding on the $5 billion or so worth of principal exposure they have to Chrysler paper.
But other investors in Chrysler debt, including smaller banks and hedge funds, didn’t want to go along. There may be a few reasons for this. The first, is that the government is running roughshod over creditor interests. A Chrysler creditor profiled in a WSJ article points out that secured creditors have a senior claim over others in a bankruptcy process. They are supposed to recover value for their assets before unsecured creditors, including employees and their pension funds:
“We did not contemplate having our first liens invalidated by a sitting president…”
The way this deal (and GM’s) are structured, the UAW and its health care trusts walk away with far more in cash and equity than if they were forced to enter a non-gov’t-sponsored bankruptcy reorganization. Debt investors are rightly unhappy about this, as their claims rank senior.
But pious arguments with respect to the rule of law may be masking other incentives the creditors have to force Chrylser into bankruptcy… (WSJ)
Bank-debt holders, many of them hedge funds or distressed debt funds, voted against the latest deal for various reasons, ranging from financial interests to philosophical ones. Some said their funds had bigger positions in Ford Motor Co. or General Motors Corp. and could benefit by a Chrysler bankruptcy and the production capacity that may eliminate. Some funds may also have credit-default swaps on Chrysler bank debt that pay out in the event of a bankruptcy.
Credit default swaps may be playing a particularly sinister role in bankruptcy filings. As reported earlier in FT, this WSJ op-ed, and a year ago on OA, CDS give their holders a perverse incentive to root for bankruptcy. Where this gets tricky is if the holders of CDS are themselves bondholders in a distressed company. Since there’s not much limit to the amount of exposure one can take in CDS contracts referencing a particular credit, it can be profitable to load up on CDS and then buy just enough of the actual bonds so that you can force a bankruptcy. You lose on the bonds you own, but gain far more on the CDS that pay out as a result…
At the same time, comments like this from the administration and from Obama are not helpful. First, this from the Prez:
“We don’t know yet whether the deal is going to get done,” he said. “I will tell you that the workers at Chrysler have made enormous sacrifices – enormous sacrifices – to try to keep the company going. One of the key questions now is, are the bond holders, the lenders, the money people, are they willing to make sacrifices, as well?”
First off, the employees have NOT made “enormous sacrifices,” not relative to the millions of other workers who’ve lost jobs recently and not benefited from government aid. And the unions played a starring role bankrupting American automakers with pay and benefit schemes that made their employers totally uncompetitive. An enormous sacrifice would be to repudiate benefits and take a pay cut in order to make Chrysler viable. But unions are a chief Democrat constituency and have to be placated. What bothers OA is Obama’s totally loaded way of describing Chrysler investors….”The bond holders, the lenders, the money people”……Why not go all-in and call them “Shylocks?”
Maligning investors is not smart. Those with capital to put at risk are the ones that are going to rescue the American economy, not the government.
Then there was this comment from an unnamed administration official:
“[Bondholders] failure to act in either their own economic interest or the national interest does not diminish the accomplishments” by Chrysler, its planned alliance partner Fiat SpA and other stakeholders in the company, the official said, “nor will it impede the new opportunity Chrysler now has to restructure and emerge stronger going forward.”
Since when are investors charged with acting in the “national interest?” As to their economic interest, that is for them to decide. If CDS are perverting their interests, well that’s one thing. But guess who helped lead the charge to keep them from being properly regulated? Obama’s top economic adviser Larry Summers.
Who’s going to want to go near distressed companies if the administration continues to add insult to economic injury?
Originally published at Option ARMageddon blog and reproduced here with the author’s permission