The Government Breaking Its Own Laws

Even if you're not an avid investor, you've probably still heard of the issues plaguing the US auto industry. It's very much been mainstream news and I've even written about it on Investing Decoded. However, like I've said previously, these problems are systemic and have developed slowly over many years. Nobody should be too surprised that the industry is in the state it is in now.

However, some of the recent developments with Chrysler have really disappointed me and are a prime example of why government and politics don't mix. Fundamentally - the government has broken its own laws - specifically contract law and incorrectly favored one party over another in the Chrysler bankruptcy proceedings.

Imagine If....

To help you understand what happened, let me set up a hypothetical scenario.

Imagine if I came up to you asking for a loan for a new company I was starting. When considering if you want to lend me the money, you would do a risk/reward assessment - is the potential money you can make from lending me the money outweigh the risk that I might not be able to pay you back. You may not do a lot of formal number crunching that investors do, but you would ask basic questions:

'What does your business do, and how likely is it to be successful?'
'If I give you the money, what do I get in return?'

Now, say I tell you, well, you can have a few options on how to loan me the money.

1. You can be a standard lender (aka creditor) - As a standard creditor, I will pay you 8% a year every year until I pay the money back. But if the company goes under and I can't pay you back I will give you 10% of the assets leftover
2. You can be a 'preferred' creditor - As a preferred creditor, I will pay you only 5% a year, but if I can't pay you, you will be 25% of the leftover assets.
   
3. You can be a shareholder - As a shareholder (i.e. you get stock in the company) you buy a piece of the company itself instead of just giving a loan. As a shareholder you'll have a say on how the company is run and can profit potentially infinitely if the company does well. However, if the company goes bankrupt, you get nothing...you lose all your money.
   

So with these options, based on your risk tolerance and the type of investment you're looking for, you can pick either one.

Chrysler's Situation

With Chrysler, there were many entities in all 3 of those categories. Also, the government owned a big piece of the company through the bailouts given last year. Well, since it went bankrupt, the assets of the company go to the creditors based on what type of creditors they were (i.e. preferred creditors get more than regular ones and stock holders get nothing). This is basic contract law that is applied in pretty much all corporate bankruptcies.

But the government had its own agenda. It turns out, the preferred creditors in Chrysler will get $.30 for every dollar they are owed in the bankruptcy. However, the United Auto Workers Union, who are essentially unsecured creditors (i.e. number 1 on the list above) will be getting $.43 to the dollar. The debt risk structure is essentially being turned up-side-down. But wait, that's not all, the UAW will also get a 55% stake in the new company - an equity stake! Some are estimating that the UAW will be recouping all of its investment.

You don't have to be a financial genius to figure out that this smells fishy. The government has undermined contract law to favor the UAW over the creditors, and Pres. Obama has pulled the 'the creditors are the very hedge funds and banks that caused the financial crisis in the first place' line to justify it. Of course, it has nothing to do with the fact that the UAW endorsed Obama and strongly campaigned for him. I'm sorry, but I'm not buying it. The precedent that this action sets can easily cause a crisis in confidence in the credit markets - and we really don't need any more of that. The dangers of government getting too involved in politics has proven itself, yet again, to be a double-edged sword.


Questions/Comments/Feedback?
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The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I've said above. This includes consulting with a financial advisor.