Obamanomics- Chrysler Style

Republicans haven't been shy about branding Obama a socialist, communist or anti-business liberal. After all, they love labels. That Obama leans left is no secret, but there really hasn't been a evidence for any of those labels to stick. I use "Obamanomics" not to denote any particular philosophy, but to capture the whole of Obama's actions in the economic realm. What I see so far is wildly inconsistent.

Take the Treasury's approach to banks. So far, Geithner has gone out of his way to protect the bondholders. "We won't let banks fail" has been the mantra, with guarantees on debt, a public-private partnership to buy bad debts and a mortgage-issuer friendly modification program. This is not inconsistent with the Bush/Paulson approach though- dilute shareholders and protect bondholders. However, this is not the natural order of capital structures in finance. Equity holders are the lowest rung on the ladder and take the first hit, followed by unsecured credit holders and finally secured holders. The government's approach has been the opposite.

Then came Chrysler. We haven't been shy about pointing out how utterly insolvent GM and Chrysler are. In the government's strong-arm negotiations with Chrysler, they took a different approach to the capital structure. The Administration proposed (demanded?) that the unsecured creditors win at the expense of the secured creditors. Secured creditors held $6.9 billion of $23.5 billion in Chrysler obligations or 29%. The UAW holds 45%. The government package allocates just 30% to the secured creditors and the rest to the unsecured UAW. In addition, the UAW gets 55% of the post-bankruptcy equity while secured holders get zippo. This flips well established bankruptcy settlements on its head where secured holders would normally get something closer to 60% in this case. (By the way, if the post-bankruptcy Chrysler commands a $10 billion market cap, the UAW will have been effectively made whole, while secured creditors took a 70% bath. According to Barron's and the proposed terms of the bankruptcy, the Treasury may end up with just $0.20 on the dollar- so much for protecting taxpayers. Not to mention Fiat getting 20-35% of Chrysler for nothing).

Tellingly, many secured debt holders voted against their own best interests. Of the 46 secured creditors, some 26 voted for the government plan despite being nearly certain to get more money back in a normal bankruptcy. Those lenders aren't just any lenders though; they are lenders who received TARP money. Banks who can't pay the TARP back and who can't pay top producers are following government orders against their best interest to placate the political choices of the Administration. Political strong-arming in practice.

To be fair, some of the non-TARP lenders are surely hedge funds and other money pools. While no one in America is on the banks or hedge funds' side right now, is a creditor wrong for acting in its best interest by asserting its contractual rights? The financial system only works when parties act in their own interest. Obama referred to them as "speculators" in a derogatory manner but many institutions regularly buy debt for nickels or dimes on the dollar. It is a normal part of finance- someone sees value where others don't, so they buy the asset (loans in this case) and attempt to recover more than they paid for it. Buffett would call that simply "investing", not "speculation".

So, with the Treasury forcing TARP money and conditions on institutions, Congress threatening cram-downs and retroactively changing contracts while established creditor rights are being trampled, who is going to be comfortable lending? On what terms will a lender be forced to lend in order to protect itself? These policies may do tremendous damage or we may (hopefully) muddle through the rest of this credit bubble unwind by coping with them. We'll see.