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latest casualty of the economic crises is the Rule of Law.
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, a private equity fund named
after the mythical creature guarding the doors of hell.
After Cerberus agreed to keep the car company going, Chrysler
celebrated with a huge fireworks display and acrobats swinging
on ropes from its roof at its headquarters in Auburn Hills,
Michigan. 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. What these lenders had not reckoned on
was the political power of the UAW, especially after the
2008 Democratic landslide.
With automobile manufacturing shifting from the unionized
factories of the Big Three– Chrysler, General Motors,
and Ford– to the non-unionized factories owned by
foreign manufacturers, including those of Toyota, the UAW
was rightly concerned that it would lose its grip on the
automotive industry. Already, in 2008, these non-union factories‹located
mainly in traditionally Red, or Republican, states whose
"right-to-work" laws prevented employees from
being forced to join a union‹were selling almost as
many passenger cars in America as the Big Three. So if Chrysler
was allowed to collapse, the UAW stood to lose heavily.
As did the Blue states in the Midwest where its factories
are located. So the UAW had little difficulty in rallying
massive support for a rescue among the Democratic leadership
of both the House and Senate. By February. President Obama
had appointed a car czar, investment banker Steven Rattner,
to come up with a plan.
The solution that Rattner and the administration endorsed
involved dividing Chrysler into two companies‹an old
Chrysler, which would be saddled with the debts, and disappear,
and a new Chrysler, to which all the valuable assets would
be assigned, including those that had been mortgaged to
the senior secured creditors. The new Chrysler would be
owned by the UAW, which would get 55 percent of the shares;
Fiat, the Italian manufacturer, which would be get 20 percent,
with the option of increasing its ownership to 35 percent
if it conformed to the targets imposed by the U.S. government;
and the U.S. government, which would get most of the remaining
shares. Fiat would essentially run the company, supplying
its small-car technology and its management (even though,
on previous occasions, its managerial efforts proved so
unsuccessful that i2005 General Motors paid $2 billion not
to buy Fiat. The new deal is a win-win for Fiat, since it
is not investing any money in the new Chrysler, and can
walk away without a penalty.
But what of the people who lent the old Chrysler money secured
by its
assets? According to the rules of bankruptcy, they were
entitled to be paid the full $6.9 billion they'd lent the
old Chrysler before those assets could be shifted to the
new Chrysler‹and before the unsecured creditors, including
the UAW's pension fund and auto-part suppliers could be
paid a cent. That was not in the car czar's game plan, however,
Instead, 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 "else" turned out to be what President Obama
described as a "surgical bankruptcy" for Chrysler
in a pre-selected U.S. bankruptcy court. Here the administration
was able to play its ace in the hole. The four bank that
held 70 percent of these loans, namely Citigroup, Goldman
Sachs, Morgan Stanley, and JP Morgan Chase, all had received
government bailout money, making them vulnerable to government
reprisals. So while denouncing hold-outs as "speculators"
and "obstructionists" or, as one Congressman from
Michigan termed them, "vultures", it was not difficult
for officials to strong-arm these banks into accepting the
deal. Using these tactics, Chrysler was able to secure the
support of more than two-thirds of its creditors. Once that
threshold had been crossed, U.S. bankruptcy judge Arthur
Gonzales was within his rights to force the remaining creditors
to approve the plan.
Whether or not this extraordinary intervention saves Chrysler,
which lost a staggering $16.8 billion in 2008, remains an
open question. After all, even those brilliant Italian organizational
skills may not be enough to persuade American consumers
to buy cars from a company emerging from bankruptcy. The
much-heralded small-car technology, meanwhile, will not
appear until 2012. 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."
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