“Did these transactions comply with the rule of law? Were the property rights of the secured creditors fully protected in the expedited proceedings? Will the process bring confidence to the credit markets? No, no and no again.”
Richard A. Epstein, “Political Bankruptcies: How Chrysler and GM Have Changed the Rules of the Game”, The Freeman December 2009.
Richard Epstein (University of Chicago), in my judgment, is the foremost legal scholar in the United States, with a deep understanding of law and economics as well as constitutional law. In a better world, he would be serving as Chief Justice of the United States Supreme Court. I draw upon his insights in this column.
By March 2009, Chrysler was bankrupt. Its liabilities, including commitments to its pension and healthcare plans vastly exceeded the value of its assets. There was no hope for a market recovery in the absence of bankruptcy proceedings. The Treasury had already thrown the Corporation a TARP lifeline of $4 billion to keep it afloat. This had proved to be taxpayer money casually flushed down the UAW toilet.
So the Obama administration determined that political bankruptcy was the solution. The President had relied heavily on union support in his election campaign. A priority goal, therefore, was to preserve the UAW retiree benefits while cutting down on the dealership contracts and haircutting the secured bondholder creditors. This could not be achieved under normal bankruptcy rules. So the rules would have to go.
There are three basic bankruptcy options: liquidation, reorganization, and sale. A government expert witness testified that Chrysler was worth $800 million if liquidated, but could be worth as much as $2 billion if sold off intact to another firm. Under bankruptcy law, the proceeds of that sale would be distributed according to a strict priority by claim type. Secured creditors, including the bondholders, come ahead of unsecured creditors, including union health and retirement funds. In the absence of a breach of the rule of law, $2 billion would leave the secured creditors a little under 30 cents on the dollar for their $6.5 billion in aggregate claims, and would wipe out all future contributions to the union retiree funds. That was just not going to happen on President Obama’s watch.
To boost the UAW coffers, Chrysler clearly had to be sold under very special conditions engineered by the government. The UAW, but not the bondholders, was given a seat at the table to determine the conditions of sale. One condition was to assume the liabilities needed to fund union health funds at sums in excess of the stated asset values of the corporation. The parties to the deal created Chrysler VEBA – the UAW Voluntary Employment Benefit Association – which received a 55 per cent equity in the New Chrysler Corporation, plus a $4.587 billion unsecured note from that company. New Chrysler was not asked to assume any liabilities for the dealers , nor would it assume liability for unsecured tort creditors (persons injured by Chrysler products).
With this reorganization in hand, the Treasury advanced a bid in the sum of $2 billion, a bid that it proudly announced to be the only bid for the company. Of course, the bid was rigged. The government was bidding $2 billion for a company that had a net worth of minus $4.2 billion. Once the government paid off $2 billion to the secured creditors, it immediately “invested” in an “unrelated transaction” an additional $6.2 billion to keep New Chrysler afloat. In so doing, it effectively moved the UAW into preferred creditor status over the bondholders who legally stood before it in the queue.
The crucial issue was whether the US courts would uphold such an illegal maneuver, or whether they would confront a new and popular administration, and uphold the rule of law. The bankruptcy court, under intense political pressure, buckled, refused to set the sale aside and to order a new sale of assets absent any prior deals. A large majority of the secured bondholders – some 99 per cent – approved a transaction that subordinated their financial interests to unsecured creditors. Prominent among these secured creditors, who sacrificed their bondholder interests, were JP Morgan Chase, Citigroup, Goldman Sachs, and Morgan Stanley. Hello! Were these not major recipients of TARP funding, errant financial institutions now completely in the pocket of the US Treasury.
One brave creditor withstood political pressure and appealed the judgment of the bankruptcy court. The Indiana Police Pension Fund, with a 1 per cent interest in Chrysler’s secured debt, challenged the decision. Ultimately, two district courts and the Second Circuit Court of Appeals denied its appeal, on the ground that no taxpayer ever has standing to challenge a transaction that affects all taxpayers.
So President Obama was able to pay off, through the taxpayer, a significant political debt to Big Labor, while signaling to all secured bondholders in the United States that they had better watch their wallets whenever Big Government assumes a stake in a distressed company.
In the event, the US government assigned to an Italian automobile company, Fiat, a significant stock share in New Chrysler – between 20 and 35 per cent depending on achieving specified market milestones – in exchange not for cash, but for access to small-car technology and some international markets. Fiat is no market-leader as an automobile company, and those milestones are unlikely to be achieved.
So much for the rule of law, when the US government becomes involved. The rule of law, remember, requires that all individuals in society, including those who govern, are subject to the same laws. Alas! We live under the rule of men, not under the rule of law, despite lip-service to that latter principle.