Dismantling capitalism: Zywicki (and Roe) on Chrysler

GMU's Todd Zywicki in today's WSJ: 

Chrysler -- or more accurately, its unionized workers -- may be helped in the short run. But we need to ask how eager lenders will be to offer new credit to General Motors knowing that the value of their investment could be diminished or destroyed by government to enrich a politically favored union. We also need to ask how eager hedge funds will be to participate in the government's Public-Private Investment Program to purchase banks' troubled assets.

And what if the next time it is a politically unpopular business -- such as a pharmaceutical company -- that's on the brink? Might the government force it to surrender a patent to get the White House's agreement to get financing for the bankruptcy plan?

My sentiments exactly.

Update:  Harvard's Mark Roe adds: 

it’ll take time to find out whether we’re going to see this one as an anomaly because of the government’s involvement or as a chapter 11 trend. If it becomes a trend, it’ll be a pernicious one. Until we find out, the result thus far won’t help get lending flowing smoothly to the weakest industrial firms in the economy’s weaker sectors.

Roe also addresses a problem that I assumed away and that Todd doesn't deal with. In order to apply the secured's "absolute priority" rights in bankruptcy, we need to know how much their security was worth.  Roe says:

Bankruptcy law entitles the secured creditors to the liquidation value of the company. With that in mind, the government and the court ought to have set up a true market test: find out how much an outsider would pay for the company’s facilities, shorn of its operations, employees and dealers.

In other words, bankruptcy potentially provides a way to reconcile the interests of all the creditors.  But the Obama administration seems more interested in simply bludgeoning the secured to submit to the politically favored unions. As Roe, Zywicki and I point out, there may be hell to pay in the capital markets, and in the economy's effort to recover.

Comments

[scott]

Why do you need to know the liquidation value of the secured creditor’s collateral for purposes of absolute priority? Absolute priority is a plan confirmation issue. See 11 U.S.C. §1129. In an administratively solvent case, lower claims can be paid before claims of higher priority without offending the absolute priority rule. The Chrysler case is not about the absolute priority rule. The tarp and non-tarp lenders have agreed, at the strong urging of the United States government, to a less favorable treatment of their claims.

Ironically, Roe, Ziwicki and your comments assume that captial markets are not efficient. In lending to Chrysler, like to any other borrower, a bank is in the best position to price its risk. If the bank thought it would be granted relief from stay to foreclose on its collateral and sell the same at auction—thereby realizing the liquidation value of its collateral—then the bank doesn’t know much about bankruptcy. If the bank thought it could continue lending to Chrysler with its contractual rights being unaffected, then the bank doesn't know much about the market. See Chrysler Corporation Loan Guarantee Act of 1979.

Chrysler’s lenders got exactly what they bargained for: they loaned money to a dying company that consistently needed life support from the government, and that previously forced creditors to receive haircuts on their "contractual" claims.

If you’re arguing against government aid in general, then that’s a different story. Without government aid (to anyone), most of the tarp-lenders, if not all, would have eventually failed, the non-tarp lenders would have failed as their investments went to zero, and the global economy would have slid into a deep depression. The true free-market people say that is good; bad companies need to fail and the market would have painfully corrected itself. The rest of the world believes it's a better idea to avoid the catastrophe.

Regardless, the market should know better than to say it didn’t think the US government would get into the car business.

[Larry Ribstein]

1. What the secured creditors will accept for their rights depends not only on their priority but on the value of the collateral.
2. Market efficiency does not necessarily assume foreknowledge of the future.
3. If the lenders knew that the government would squeeze them when they loaned the money, and the debt was priced accordingly, then I guess the future I feared is already here.