Chrysler’s scary backseat driver

May 11, 2009 by Tom Bowden

So, Chrysler has filed for bankruptcy. You might think I’d be celebrating, having urged President Obama back in February to “let bankruptcy courts take the wheel” instead of bailing out the auto companies. As I said then:

If an automaker can return to profitability by streamlining products, cutting staff, or closing plants, a bankruptcy judge can allow a reorganization. But a company that’s hopelessly floundering may have to be liquidated through an orderly sale of assets, with income paid to creditors according to their existing contract rights.

Unfortunately, the bankruptcy filing is overshadowed by the Obama administration’s attempts to sabotage the debtholders whose contracts entitle them to first crack at Chrysler’s assets. Instead of letting bankruptcy law drive the process, Obama has become everybody’s nightmare–the backseat driver who barks orders and threats, and leans forward as if to seize the wheel. 

Bankruptcy law normally makes a sharp distinction between secured and unsecured creditors. A bank or pension fund is a typical secured creditor. Suppose a bank lends Chrysler $50 million. In exchange, the bank receives a contractual right to be paid ahead of other creditors if the debt goes unpaid. In the event of bankruptcy, the lender and other so-called secured creditors “go to the head of the line.” In most cases, only after the secured creditor is fully paid (100 cents on the dollar) do unsecured creditors get anything. Even if a company is failing, its cash reserves and hard assets (such as machinery, real estate, and accounts receivable) may be enough to pay the loans in full.

Other creditors, who are unsecured, are told to “go to the back of the line” behind the secured creditors. Those unsecured creditors might include material suppliers, customers, and employees. They typically receive only a few pennies, or nothing at all, for each dollar they are owed.

In Chrysler’s case, secured creditors have contractual claims on about $7 billion of the company’s assets. Enter Obama’s minions, who exerted strong-arm tactics for them to abandon their security interests and take thirty cents or less for each dollar of debt. Why? To leave more of Chrysler’s carcass for the union and its health fund to feed on. Some of the secured lenders succumbed to the pressure, but a group of about 20 refused to compromise. Obama has castigated them as “a small group of speculators” whose decisions “endanger Chrysler’s future.” The bankruptcy filing followed.

Declan McCullagh has an incisive article exposing the government’s thuggish tactics. Read this passage–which, if true, is shocking–quoting a lawyer for the dissident creditors:

“I represent one less investor today than I represented yesterday,” [Thomas] Lauria said on a Detroit radio show. “One of my clients was directly threatened by the White House and in essence compelled to withdraw its opposition to the deal under threat that the full force of the White House press corps would destroy its reputation if it continued to fight. That’s how hard it is to stand on this side of the fence.” Lauria said that his clients were willing to compromise on 50 cents on the dollar, but the government offered them only 29 cents.

Now it’s up to the federal bankruptcy court in Manhattan, in the person of Judge Arthur Gonzalez, to protect the secured creditors’ rights. He handled the Enron and WorldCom cases, so he’s loaded with experience. But bankruptcy laws are complex, judges have significant discretion, and the political stakes are high. Will contract rights be vindicated in the Chrysler case? It’s too early to tell.

One thing we do know: Obama need not directly interfere with the court’s actions in order to determine the outcome. Court cases go forward only if there are disputes among the parties. If Obama continues to coerce the parties outside the courtroom, then the dispute over secured debt might yet be “settled” out of court and the issue withdrawn from the court’s purview.

By such steps, a President gathers arbitrary power. A few months ago, he strong-armed the banks and other financial institutions–and got away with it. Now he’s bullying private creditors–and getting away with it. The time is coming, if it hasn’t arrived already, when American businessmen will lose all hope of making and enforcing contracts under a rule of law.