The GM Deal Stunk, But This Chrysler Deal Reeks

"It is an old fallacy that it is a legitimate task of civil government to protect the less efficient producer against the competition of the more efficient....Such a privilege conveys to the privileged the benefits which the unhampered market provides only to those who succeed in best filling the wants of the consumers."

- Ludwig von Mises, Human Action

Let no one now doubt it -- the last few weeks have laid bare Barack Obama's intent and willingness to strong-arm American industry to conform to his wishes. I speak of the convoluted arc of the Chrysler Corporation, as its lenders and the State played chicken, with the State prevailing.

To recap, during Chrysler's painfully slow slide toward bankruptcy, it borrowed money from lenders, who were granted "senior-debt" status. (In bankruptcy, there is a hierarchy of payback as follows: bank debt, senior debt, junior debt, accounts payable, preferred stock and then common stock.  This hierarchy is solidified in federal law.)

This translates during bankruptcy roughly as follows:  repayment (usually via sale of assets) at 100 cents on the dollar starts with the most senior creditors, and continues down the rungs to subsequent debt-holders until all assets are liquidated.  Usually, common stockholders receive, at most, pennies on the dollar -- this risk is also why common stockholders have the greatest upside with concomitant company success.

In Chrysler's case, lenders with senior-debt status included major banks, hedge funds, and asset managers.  The United Auto Workers (UAW) had a financial stake in Chrysler via a trust fund for retiree health insurance.  (Similar to the arrangement the union had with GM, discussed previously.)  This trust fund had junior-debt status, meaning it stood in line behind other lenders to be repaid in the event of bankruptcy.

Now, Obama and the Democrats ABSOLUTELY do not want any auto manufacturer to go bankrupt, because that would be the death knell for the still-lush salaries and benefits of its union workers.

And, much more importantly, it would probably cripple the political donations made by the UAW to Democrats.  And we are not talking about meager amounts, either:  since 1990, the Center for Responsive Politics reported that the UAW has donated over $25 million to political campaigns -- of which 99 percent has gone to Democrats.  There is a better chance Obama will be honored at the National Rifle Association than Democratic politicians will not pull out all stops to protect the UAW.

So, when it became clear that Chrysler was perilously close to bankruptcy, panic mode set in at the White House.  (After all, the UAW spent nearly $5 million to help get Obama elected.)  The Administration crafted a deal whereby the UAW would own 55 percent of Chrysler, the Italian auto maker Fiat would own 35 percent, and the government 10 percent.

Obama offered the senior creditors 32 cents on the dollar for their stakes, and managed to "convince" many of the lenders to accept the offer.  Four banks holding 70 percent of the debt agreed to a deal, while other lenders held out, believing they could get 65 cents on the dollar in a bankruptcy hearing.  Since all of the lenders could not agree to terms, Chrysler declared bankruptcy this past week.

Now, about those four banks who agreed to the deal?  It just so happens that they -- J.P Morgan, Citi, Morgan Stanley and Goldman Sachs -- received billions and billions of dollars from the Troubled Asset Relief Program (TARP) and other subsequent bailouts.  As a result, they were in no position to resist Obama's offer -- he owns them.  (Live by the sword, die by the sword.)

Obama then went on the offensive with a briefing to shame the remaining lenders that did not accept his absurd offer.  His remarks are worth noting as exemplars of the audacity of doubletalk.  Portions follow:

"But as I've said from the start, we simply cannot keep this company, or any company, afloat on an endless supply of tax dollars. My job, as President, is to ensure that if tax dollars are being put on the line, they are being invested in a real fix that will make Chrysler more competitive."

Actually, I don't think he's ever said "that" from the start.  However, simply by stating that he has, he's granted himself legitimacy as a good steward of American taxpayer dollars.  Which, given his sickeningly bloated $3.4 trillion budget for FY 2010, is such a baldfaced lie that I am baffled how anyone but a narcissistic politician (pardon the redundancy) can deliver those words with a straight face.

Additionally, he only refers to our money he's spending as "taxpayer dollars" when it suits his purposes to be seen as respecting this great responsibility he's been given.  Most of the time, when he is discussing one pet spending plan after another, our hard-earned money is referred to as "investment funds," or other such nonsense.

To continue:

"But over the past month, seemingly insurmountable obstacles have been overcome, and Chrysler's most important stakeholders -- from the United Auto Workers to Chrysler's largest lenders ... -- have agreed to make major sacrifices."

Priceless.  The "important stakeholders" he references who have made "major sacrifices"?  The UAW has been granted a potentially sweeter deal than it received under the GM reorganization.  The UAW will own a majority stake in Chrysler -- just let that percolate for a while -- even though it was far down the pecking order in terms of being repaid.  

This issue is the linchpin of why so many people are outraged over the Chrysler deal.  Let me be clear -- Obama flouted long-standing bankruptcy jurisprudence by moving the union up the repayment hierarchy, ahead of senior creditors.  These actions are probably illegal, but who in their right mind is going to cross paths with a president?  It would take years for a case to work its way through the courts; in the meantime, the bully pulpit you have doesn't even begin to compare to the bully pulpit the president has.  Not even close. 

But the interpersonal, Administration-versus-company controversies are but a sideshow to the real problem.  What do you think might happen to investment capital now?  Companies lend funds at lower rates, as long as they are granted senior-creditor status.  (In other words, lenders are willing to accept lower interest rates in exchange for a greater likelihood that they will receive a greater proportion of their principal back if bankruptcy occurs.)  

What lender, in his right mind, would offer to lend money at a low rate if they cannot even trust their place in line for repayment during bankruptcy?  Therein lies a major reason why the State, with its disproportionate influence above and beyond its expertise, should not become directly involved in private-sector financial transactions.

And, given that our president has so little business education that he does not understand that profits and earnings are the same, businesses are going to be loathe to tiptoe out on a limb the least bit.  This Administration might saw off that branch, either to help another party or out of sheer ignorance.

This scenario, single-handedly created by the Administration, has the potential to stifle lending as much as, if not more so, than the subprime lending mess.  Amity Shlaes, who wroteThe Forgotten Man: A New History of the Great Depression, has a thesis that the Hoover and Roosevelt Administrations prolonged, and deepened, the Great Depression with their inconsistent and unpredictable business interactions and decisions.  Companies that must deal with an uncertain capital, investment, or regulatory environment are much more likely simply to hoard their cash, and ride out the storm.

More from Obama's briefing:

"Fiat has demonstrated that it can build the clean, fuel-efficient cars that are the future of the industry, and as part of this agreement, Fiat has already agreed to transfer billions of dollars in cutting-edge technology to Chrysler to help them do the same. Fiat is also committed to working with Chrysler to build new fuel-efficient cars and engines right here in America."

This paragraph says the following:

1. Arrogance.  No one person -- not even Obama -- knows what the future of the automotive industry holds.  The "future" of the industry is going to be reliant upon millions of people investing and spending billions of dollars.  The assumption that fuel-efficient cars are the future is preposterous, given that SUVs, pickups, and other large cars are the best-selling vehicles, are the only profitable auto models, and the price of gas is fluctuating wildly.  It is possible -- perhaps even likely -- but not written in stone.
2. Public-sector strong-arming.  "As part of this agreement, Fiat has agreed to transfer billions of dollars in cutting-edge technology...."  In other words, Fiat would not have been able to take a large ownership stake in Chrysler unless it "transferred" billions of dollars of technology.  It also implies that, if it had a choice, Fiat would not have transferred billions of dollars of technology to the U.S.  People who run Fiat are not stupid -- they understand where, and how, the best use of their capital should be deployed.

"The United Auto Workers, who had already made painful concessions, agreed to further cuts in wages and benefits; cuts that will help Chrysler survive, making it possible for so many workers to keep their jobs and about 170,000 retirees and their families to keep their health care."

We should all be so penalized.  Only in a world where profits and earnings are different is being given 55 percent of a company considered a "concession."  The UAW, with its demands for above-market wages and benefits, played a key role in the demise of the U.S. auto industry.  It is not a coincidence that Ford, having been able to secure major concessions from union auto workers, is the only major U.S. auto manufacturer not to have to go begging and pleading to the government for an allowance like a teenager.

Additionally, if it was the "cuts" that "will help Chrysler survive," does that not imply that wages and benefits were already too high?  Seems to me that, if a salary cut is necessary to keep the business open, the business model has incorrect assumptions about wage levels.  That company better react to those market signals ... or else lights are getting turned off.

"Several major financial institutions, led by J.P. Morgan, agreed to reduce their debt to less than one-third of its face value to help free Chrysler from its crushing obligations."

No, no, no.  "Several major financial institutions ... agreed to reduce their debt" because the government had already extended them billions of dollars in grants and loans, thus creating an implicit dependence on the federal government that vaporized any negotiating power.

"While many stakeholders made sacrifices and worked constructively, I have to tell you some did not. In particular, a group of investment firms and hedge funds decided to hold out for the prospect of an unjustified taxpayer-funded bailout. They were hoping that everybody else would make sacrifices, and they would have to make none. Some demanded twice the return that other lenders were getting. I don't stand with them."

This "group of investment firms and hedge funds" was honoring their fiduciary obligations to their customers and clients.  (As was Obama to the UAW, one could say.)  An investment or hedge fund (or major bank, for that matter) is obligated to secure the greatest return on investment capital.  It is absolutely not obligated to accede to a government's wish to decimate the value of its holdings so that other parties may be rewarded with a majority stake in the new company.  That is not the free market, nor is it capitalism, nor is it even "light regulation."  It isn't even fascism, as some are implying.  Once the government controls the factors of production, you have the "S" word ... socialism.  (Don't say it loudly, else you'll simply be blasted by someone who does not even understand the economic underpinnings of the philosophy.)

An argument can even be made -- should be made -- that the four TARP-suckling banks (J.P Morgan, Citi, Morgan Stanley and Goldman Sachs) dishonored their fiduciary obligation toward their clients and customers.  Those banks did their customers a huge disservice by accepting the government's proposal without even putting up a fight.  The same cannot be said for the holdouts.

So, we are now looking at ChryslerUAW, or maybe UAWChrysler.  Those who appreciate the business world can take some small solace in envisioning the next union negotiations between UAW-as-Owner versus UAW-as-Workers-Champion.  I'm already anticipating the first $400K annual salary for an entry-level die-cutter.