The Chrysler Bankruptcy: Creditors Hit the Wall

Secured creditors, the most favored class in finance, were probably glad to have this weekend to catch their breath after the Chrysler bankruptcy filing. They went eyeball to eyeball with the Obama administration in the Chrysler bailout negotiations, and didn't get what they wanted. Apparently, a large portion of Chrysler's secured debt was held by hedge funds and speculators of similar ilk that bought their holdings for pennies on the dollar and were hoping to extract more pennies from the government as part of a non-bankruptcy bailout. Faced again with the specter of Wall Street profiteering at the expense of middle class taxpayers, the Obama administration bargained hard for concessions. The secured debt holders played a classic game of Wall Street brinksmanship, and the company went over the brink into bankruptcy court.

The secured debt holders probably guessed that after the Lehman bankruptcy, where the Bush administration tried to impose discipline on creditors and wound up bailing out AIG's creditors dollar for dollar, the government would flinch whenever debt holders stood firm. But they may have failed to look objectively at political reality. The American taxpayer is fed up with bailouts for the wealthy, and the Obama administration may recognize that there is a limit to the government's borrowing and printing of money. Even though the U.S. government can run a marathon of a deficit, sooner or later it will hit the wall. And it did with the Chrysler situation.

The creditors are now stuck slugging it out in bankruptcy court, where they would have been if the government hadn't been around for them to try to game. Faced with having to rest on their legal rights, they may succeed to asserting their liens on Chrysler's assets. But so what? Who will buy those assets? There is only one ready buyer who will pay anything approaching a semi-passable price, and that's Fiat supported by the U.S. government. Those are the same players that the creditors just failed to game. With the auto market shrinking dramatically, Chrysler's factories and manufacturing equipment are basically surplus capacity. Few investors will buy production equipment that makes products with no market. The secured creditors won't realize much more than scrap value if they try to auction off Chrysler's hard assets piecemeal. The only significant value in this bankrupt's estate lies in selling some portion of Chrysler as a going concern, with the tradenames that for decades have meant something to Americans. So the secured creditors will probably find themselves again staring at the U.S. government and Fiat as the only buyers willing to pay anything substantial for Chrysler's assets. Do they think they'll see much improvement in the price offered?

By taking creditors off the pedestal that the Bush administration put them on with the AIG bailout, the Obama administration has done well for taxpayers. The GM bailout remains on the negotiating table, and the lines in the sand are now clearer. A resolution with GM's creditors may now be easier. Even more importantly, creditors of large financial institutions must now be furrowing their brows over the possibility that the U.S. government might not pay them out dollar for dollar. Perhaps they're even beginning to perspire. That's not a bad thing. It took a lot of creditor participation to make the big banks too big to fail. If creditors realize that too big to fail doesn't mean too big for creditors to take a loss, then some degree of rationality might return to the money markets. Markets where certain players cannot lose are destined for dysfunction, and that's where we are with today's credit markets. Perhaps creditors will in the future be less eager to participate in the over-leveraging of already large banks.

"Irony" is used way too much in today's public discussion. But one irony of the Chrysler situation is that a foreign auto company may end up being the biggest winner. That shouldn't provoke too much concern. All auto companies today with any chance of success are multi-national. Toyota is famously global, sometimes shipping a few thousand vehicles a year to dusty third world countries that most sales executives in Detroit never heard of. One reason why Toyota compact pickup trucks perform so well is that they have been tested in every imaginable environment. Ford and GM have a chance of survival in part because they have worldwide operations. Chrysler was too heavily concentrated in North America, and was highly vulnerable when the North American credit bubble popped. Linking the surviving parts of Chrysler with Fiat strengthens both companies. Many people employed at Chrysler and its parts suppliers won't be returning to the plants, because their jobs are gone forever. However, some will if the Chrysler bankruptcy reorganization is successful, and many dealerships could survive as Chrysler/Fiat dealerships. Perhaps 100,000 or more jobs could be saved.

Government assistance in the economy has a long history in America. The Erie Canal, the homesteading of the West, the national railroad system, the air transportation system, the interstate highway system, and the enormous tax and finance subsidies for residential real estate are just some of the most obvious examples. Government safety nets like unemployment compensation, health insurance for many of the needy, and worker retraining programs play important roles in softening the harshness of capitalism. Manufacturing is part of the core of any strong economy, and some government assistance to preserve manufacturing jobs is likely to be money well-spent. We can't build an economy processing paper for home loan refinancings and mortgage securitizations. We need to make things--things people want to buy. Let's hope for a successful reorganization of Chrysler in bankruptcy court.