Tuesday, May 12, 2009

"The latest casualty of the economic crisis is the rule of law."

... is the opening sentence of a piece in Vanity Fair by Edward Jay Epstein ("The Czar's Rules Apply at Chrysler"). (Hmmmm, even Vanity Fair writes about this topic...)

"Consider the sad case of Chrysler. Its troubles became manifest in 2007, when it was owned by the German auto giant, Daimler, and it was unable to come to terms with the United Auto Workers labor union (UAW). Rather than suffer more losses from an unfavorable union contract, Daimler decided to rid itself of Chrysler by handing over 80 percent of its ownership to Cerberus Capital Management....

"Chrysler then borrowed $10 billion from a banking syndicate, led by J.P. Morgan Chase, Citigroup, and Goldman Sachs, to fund its operations. The loan was secured by mortgages on Chrysler’s real estate, manufacturing plants, patents, and highly profitable brand licensing rights. (Jeep alone earned $250 million a year licensing its name to toys, clothes, and other products.)

"The lenders assumed (incorrectly, as it turned out) that their secured loan, which was senior to any other Chrysler debt, would be protected even if Chrysler went bankrupt, since the iron rule of bankruptcy held that secured loans get fully paid before unsecured loans. Without this rule, financiers would be reluctant to lend money to corporations on their assets."

WRONG! (That was before this administration came in. We are in a new era now.)

"... the creditors were confronted with a take-it-or-else offer of 29 cents on the dollar, substantially less than the unsecured creditors would receive. (The UAW’s fund, for example, would receive an implied 55 cents on the dollar.) The “or else” turned out to be what President Obama described as a “surgical bankruptcy” for Chrysler in a pre-selected U.S. bankruptcy court."

Fiat is the clear winner, who is not putting any money and getting 20% stake. The next in line is UAW, with UNSECURED claims (pension fund) and still ending up with 55% stake

"But the consequences of upending the rule of law, even if it was done with the best of intentions, may prove far more serious than whatever befalls Chrysler in the Rustbelt. For one thing, it will undoubtedly become far more difficult for an American corporation to borrow money on its assets, since even a senior secured lender can no longer be sure his claim will take priority over those of labor unions and other unsecured creditors.

"As one savvy investment banker told me, “Now that we live in a banana republic, secured lending is anything but secure.”"

Money will flee.

By the way, according to Zero Hedge, none of the Chrysler's senior debt holders (non-TARP lenders, mind you) has CDS on their debts. They thought, as this article points out, they were protected by the bankruptcy law.

"Fiat" is such an appropriate term for this sorry saga. It means in original Latin "Let it be". In modern usage, it means "an arbitrary order or decree".


Rock Roger said...

Good post about credit crisis . Now we should only use these types of unsecured loans in real financial emergencies. They help in our tough timings.

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