The reason the government is involved in this process at all is that everyone assumes that, in the event of a bankruptcy of one of the major auto companies, nobody will be willing to offer debtor-in-possession financing to keep them running while they are reorganized under Chapter 11, and therefore we’d proceed to liquidation. Which, in this environment, means liquidation at a firesale price, with outsized losses to investors and stakeholders and a cascade of follow-on economic consequences from the failure of parts suppliers, dealers, etc.
Therefore, the general assumption is that the government would need to step in somehow to prevent that calamity – either by bailing out the companies directly (as was done in the waning days of the Bush Administration), or by agreeing to provide DIP financing in bankruptcy. In either case, the government would be significantly intervening in the capital markets to protect what was perceived to be a public interest.
So the government was at the table before the table was set. Before the hedge funds bought this distressed secured debt, they knew that the government was a major player in determining the outcome for the various stakeholders in the auto companies. Among the many factors in their investment decision, preeminent was the need to try to game what the government was going to do.
It’s very hard, once that context is established, for me to get terribly exercised about the Administration’s decision to play hardball negotiator on behalf of the UAW. Ever since the auto companies showed up on Capitol Hill begging for a bailout, they became political enterprises, and investors at every level must have understood that.
Bondholders in Washington Mutual at the holding company level got a windfall in bankruptcy because the FDIC pulled all the assets out of the operating company before the cash at holdco could be downstreamed; investors in debt of the holdco, meanwhile, got zippo. That was a political decision. When Fannie and Freddie were nationalized, preferred stockholders got zero and subordinated debtholders got par. That was a political decision. When AIG got bailed out, Goldman and Merrill got their payments (and were saved from bankruptcy) and AIG bondholders got bailed out while AIG shareholders weren’t even in the room for the negotiation. That was a political decision. Every owner of municipal debt in this country is the beneficiary of the political decision to partly nationalize the obligations of states and municipalities across the country. The government is way, way deep in its involvement in the allocation of capital in the economy at this point. To expect the government to simply ignore the various competing interests at play in these decisions is not only unrealistic – its probably a bad idea.
And, at the end of the say, this whole thing is winding up in bankruptcy court after all. The Obama Administration made an offer they thought the hedge funds couldn’t refuse. But they refused, and now a judge will decide what to do. The Administration will still be in the room, of course, because if the company wants to get capital to operate while it restructures and gets chopped up for Fiat to digest, it will need government assistance – and that assistance will come at a price.
Let me be clear about one thing. If allegations that the Obama Administration threatened to use the IRS to punish some of the hedge fund holdouts are true, then there’s been actual criminal activity and there should be a full investigation. But short of that kind of abuse of the government’s police power, I can’t get that excited about the government favoring this or that stakeholder. What did you expect would happen when you invite the government into your company?
We will get back to private allocation of capital not when the government decides to honor the priority of secured bondholders when proposing a solution for a particular company that avoids a bankruptcy process, but when the government is no longer expected by the private markets to be involved in allocating capital. That’ll be when the TARP is unwound, quantitative easing ends, etc. That won’t be soon.