May 13, 2009
Capital markets players have been grumbling that Chrysler's creditors are being badly treated and that their contract is being ignored. Warren Buffett said last week that there'll be "a whole lot of consequences" if the government's Chrysler plan keeps on its current trajectory. If priorities are tossed aside, "that's going to disrupt lending practices in the future," he said. "If we want to encourage lending in this country," Buffett added, "we don't want to say to somebody who lends and gets a secured position that the secured position doesn't mean anything."
This is not a good economic time to disrupt lending to troubled companies. That's just the kind of lending that the Treasury is trying to unglue with TARP and the plans to sign-up private investors to buy the toxic mortgage assets off bank balance sheets.
But is this gelling capital market opinion on the Chrysler plan right or wrong? Maybe there really isn't any more value in the government's last offer than belongs to the Chrysler creditors. If there isn't, Buffett and lenders are getting themselves unnecessarily worked up.
The trouble is that with the bankruptcy set-up approved this week, no one can tell. There's no real market check on the Treasury plan, just a pseudo-market test that won't fool any market player. This pseudo-test, approved by the court last week, led Chrysler’s dissenting creditors to give up.
In the test approved, outsiders can bid the deal away from Fiat and the U.S.,But bidders can bid on only one deal -- the same UAW deal that the government negotiated before the bankruptcy. The court agreed to Chrysler's and the Treasury's proposal that no one be allowed to bid on the assets alone. But that's what Buffett and the capital markets grumblers are complaining about: the government, and now the bankruptcy judge, is ignoring creditors' contracts priority access to a first cut at Chrysler's assets. The deal on the table gives them no access to those assets.
But there was a way to check the bona fides here to convince Buffett and financial players that the deal was fair: the court could have market-tested the plan. If the court and the Treasury had given Buffett and others the chance to outbid the Treasury for those assets and Buffett didn't bid more than the Treasury, grumbling would have ended. If Buffett or someone else credible came in with a better bid, the Treasury and Chrysler would then have had to top it.
The best way to think about the bankruptcy plan is that the government is buying Chrysler from the creditors, giving it to the UAW, and hiring FIAT to manage it. Financial markets players are grousing that the UAW and the retirees are doing much better than the secured creditors. The UAW is owed $10 billion and they'll get a big fraction of that back while the secured creditors take a big hit to their $6.9 billion in loans. But if the Chrysler winners are doing better with the government's money and not the creditors' money, that's not for the creditors to complain about in the deal itself (as opposed to complaining as citizens and taxpayers.)
Bankruptcy law entitles the secured creditors to the liquidation value of the company. With that in mind, the government and the court ought to have set up a true market test: find out how much an outsider would pay for the company's facilities, shorn of its operations, employees and dealers.
Setting this up to elicit credible bids would be imperfect, but an active judge could have done better than what we have now. If the complaining creditors couldn't find one credible bidder willing to offer the judge a bid topping the government's offer, then the government's $2 billion for $6.9 billion offer is basically fair and shouldn't demoralize either Buffett or capital markets. An activist judge should have been thinking in these terms. And the Treasury, if thinking more as a policymaker trying to unglue credit markets than as a dealmaker trying to get the last possible dollar in a Chrysler deal, should have as well.
The bidding structure could still be added to this week, but the train sure seems to be running on this one and no one should expect it to be fixed. Worse yet, there's credit market buzz that even Chrysler's own valuation people acknowledged: a sale of the company assets could have brought in noticeably more than the amount the creditors will get. The valuation estimates that Chrysler filed with the court showed a range of liquidation values that, although centered around the deal in play, had its high-end estimate above what the wounded creditors get in the plan.
It's too easy for the auto task force -- dealmakers in their prior careers -- to get caught up in pushing through this deal on the best terms possible, while losing focus on the deal's impact on financial players' psychology. The administration's economic policymakers should have wanted a real market test.
Not everything that's good for a Chrysler rescue is good for the United States. The interests of the administration and the economy are not the same as those of Chrysler and the UAW's; the latter two want any deal done that preserves their interests. If the deal bars any outsiders from making a real competing bid on the assets, all the better. The Treasury though, having decided to rescue Chrysler and the UAW, should have wanted a deal done that does little to disrupt capital markets' confidence in their contracts.
But that's not what we got in the first week of the Chrysler bankruptcy. It's getting done in a way that unnecessarily disrupts financial markets' confidence in lending to troubled firms, including via the TARP's proposed public-private partnership, by roughing up bankruptcy's normal lender protections. But it didn't have to do this. Chrysler had reason to play it as hard-edged as possible; the United States Treasury did not.
Worse, if the current deal becomes a strong bankruptcy court precedent, it'd throw priorities into question generally, because the tactics are easily imitated even without the government as the major player. In chapter 11 reorganizations going forward, if a coalition of creditors and insiders can convince a judge to use the same structure as the Chrysler judge has provisionally approved, they can freeze out a creditor group who then couldn't call on any of bankruptcy law's normal protections. Not all judges, we can hope, would go along with this Chrysler-like structure, but it'll take time to find out whether we're going to see this one as an anomaly because of the government's involvement or as a chapter 11 trend. If it becomes a trend, it'll be a pernicious one. Until we find out, the result thus far won't help get lending flowing smoothly to the weakest industrial firms in the economy's weaker sectors. Buffett isn't making it up.
Hence, the friendly observation I offer the Treasury here as a sympathetic observer: the Treasury shouldn't want to damage American lending markets with its Chrysler bailout hand while it's trying to restore bank lending with its TARP hand. And it didn't have to. It still could, and ought to, fix this up in the Chrysler bankruptcy. If not, everyone involved will get another chance to do better. GM is up next.
Mark Roe is a professor at Harvard Law School, where he teaches bankruptcy and corporate law.