Why I celebrate Chrysler's petition for Chapter 11 reorganization

Count me as one person entirely unsurprised to read that representatives of the Obama Administration were making outrageous and improper threats to the Chrysler bondholders whose refusal to capitulate ended up in Chrysler's Chapter 11 filing. White & Case bankruptcy lawyer Tom Lauria gave a radio interview to Detroit talk radio host Frank Beckman, portions of which are transcribed here, in which he said:

One of my clients was directly threatened by the White House and in essence compelled to withdraw its opposition to the deal under the 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.

Beckman: Was that Perella Weinberg?

Lauria: That was Perella Weinberg.

And Obama himself actively participated in the shakedown:

Peter A. Weinberg and Joseph R. Perella are part of a band of Wall Street renegades — “a small group of speculators,” President Obama called them Thursday — who helped bankrupt Chrysler.

That, anyway, is the Washington line.

In fact, Mr. Weinberg and Mr. Perella, with sparkling Wall Street pedigrees, are the epitome of white-shoe investment bankers. And their boutique investment bank, a latecomer to Chrysler, played only a small role in the slow-motion wreck of the Detroit carmaker.

But now the two men, along with a handful of other financiers, are being blamed for precipitating the bankruptcy of an American icon. As Chrysler’s fate hung in the balance Wednesday night, this group refused to bend to the Obama administration and accept steep losses on their investments while more junior investors, including the United Automobile Workers union, were offered favorable terms.

In a rare flash of anger, the president scolded the group Thursday as Chrysler, its options exhausted, filed for bankruptcy protection. “I don’t stand with those who held out when everyone else is making sacrifices,” Mr. Obama said.

Chastened, and under intense pressure from the White House, the investment firm run by Mr. Weinberg and Mr. Perella, Perella Weinberg Partners, abruptly reversed course. In a terse statement issued shortly before 6 p.m. Thursday, Perella Weinberg Partners announced it would accept the government’s terms.

It was too late.

What made Perella Weinberg ultimately give in, when others like Oppenheimer Funds refused? One word: Vulnerability (emphasis mine):

Representatives for Perella Weinberg, which is advising the government on a wide range of banking issues, initially defended the firm’s decision to rebuff the government’s offer.

(Recall that I blogged on March 26 of this year about the odd fact that Obama's chief of staff, Rahm Emanuel, had earned somewhere between $16-$20 million in something between two and three years as an investment banker at Wasserstein Perella & Co. when the Clinton Administration went into exile in 2001, even though Emanuel had zero education, training, or experience as an investment banker or any sort of businessman. And yes — that's the same Perella; he'd moved on to Morgan Stanley by the time Emanuel was at Wasserstein Perella & Co., but it's such a small world, isn't it?)

Glenn Reynolds and Ed Morrissey note the White House press corps' silence — which might be read to imply acquiescence — about being used as part of this threat. And I agree that that's an interesting facet of the story.

The bigger story, however, is that the Obama administration is engaged in a colossal abuse of power whose magnitude far exceeds a mere subversion of the White House press corps. Barack Obama has become Guido, the thug who everyone knows has not only a nasty habit of, but a nasty taste for, breaking kneecaps. And the beneficiary of his current shakedowns are the United Auto Workers.

Obama is counting on the fact that many, probably most, Americans don't know or care about basic principles of corporate finance. But the fact is that all investments — stocks, bonds, notes, commercial paper, CDs, demand deposits, mutual fund shares, whatever — are legal contracts whose very nature is defined by the way they structure and allocate risk of default and prospect for profit.

On the simplest level, for example, in general, people who buy equity in a business, typically by purchasing shares of its common stock, have the greatest potential upside if the business is profitable because they're buying a percentage interest in it, and if the pie keeps getting larger, so too will their slice of the pie. Someone who instead merely loans money to that business — by buying, for example, notes or bonds or debentures that are, at bottom, fancy IOUs — generally forgoes that upside potential, and instead takes only a promise for repayment plus some specified and limited amount of interest. But in general, those who invest by loaning money to businesses also have less risk, because in bankruptcy proceedings — again, speaking on the broadest of terms, and as a general rule — creditors who are owed money by the bankrupt company's estate are ranked, and then paid or otherwise accommodated, before any equity owners (shareholders) get anything. And as a consequence, it's very typical for creditors to get pennies on the dollar, perhaps plus some shares of equity in a reorganized "new" post-bankruptcy company, while the shareholders have been wiped out completely.

And among creditors, there are also rankings. Those who've insisted upon and gotten collateral for their loans — making them "secured creditors" — generally forewent higher interest rates in exchange for the pledge of that collateral. Those who have no collateral, but merely a general, unsecured claim for repayment, are "unsecured creditors." They relied only on the company's general credit-worthiness and, to a lesser extent, the better treatment that even general unsecured creditors get in bankruptcy as compared to equity holders.

I repeat, this is all basic to the entire system of business investments. If these core principles are disturbed, there will be no more capital markets — no ability to buy shares of stock or corporate bonds, no way for growing companies to expand by selling equity or taking on debt.

What the Obama Administration has been trying to do, however, has been to cajole or — it's now becoming more clear — threaten people who carefully bargained for less risk, and who thereby had to settle for lower rewards all along, into voluntarily forfeiting the protections they bought and paid for in the event of the underlying business' insolvency. Primarily through Chrysler's pension and retiree health-care obligations, the UAW is a creditor of Chrysler, but one whose position is less favored by the bankruptcy laws than the investors (debt holders) represented by companies like Oppenheimer Funds or Perella Weinburg. Unlike the UAW, their clients negotiated, bought, and paid for the rights not to have to have to make the same "sacrifices" that equity holders or general unsecured creditors would be compelled to make under the bankruptcy laws. But Obama insists — on pain of presidential demonization and worse — that these so-called "renegades" and "speculators" (who've actually been guilty of nothing other than greater prudence) make those sacrifices anyway, and that they do so specifically in order to benefit the UAW!

This goes beyond populism or pro-unionism. Barack Obama is engaged in an assault on not just the entire system of business in the free world, but on the American rule of law upon which it is founded. And that, gentle readers, is why I celebrated Chrysler's Chapter 11 filing. Instead of backroom deals made through strong-arm tactics, whatever happens now will take place under the disinfecting sunlight of the United States Courts. And that will, in turn, help frustrate Barack Obama's scheme.

Oh, I fully expect that even in bankruptcy court, the Obama Administration will continue to work hard to tilt the playing field to favor the UAW and to disfavor everyone else. It will continue to at least try to call most of the shots as Chrysler struggles toward a reorganization plan. And it's not inconceivable to me that Obama will try to enlist Congress' cooperation — custom "tweaks" of the Bankruptcy Code — in an effort to do so.

But it's going to be harder for the Obama Administration to continue making these unconscionable threats now that there is at least some due process structure that must be followed. And while the federal government is frequently involved in one way or another in bankruptcy proceedings, I can confirm to you from personal experience that it doesn't always get its way there. (But that's a long story I'll save for another day.)

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UPDATE (Sat May 2 @ 8:00pm): As has often been disclosed elsewhere on this blog and on my professional website, although bankruptcy court litigation has been only an occasional part of my practice, I was a litigation partner at Weil, Gotshal & Manges from 1989-1991. WG&M has long represented General Motors; I did trivial amounts of work for GM when I was at WG&M; and WG&M will likely be its bankruptcy counsel when and if GM also files for Chapter 11 protection. Oppenhemier & Co. was also a WG&M client when I was there, and I represented it from time to time on non-bankruptcy related matters. But I don't currently represent anyone with an actual or potential interest in either the Chrysler or (potential) GM bankruptcies, and my current practice mainly focuses on representing small businesses — some of whom are debtors and some of whom are creditors, but all of whom respect and abide by the rule of law that Barack Obama is trying to undermine.

UPDATE (Sat May 2 @ 8:45pm): Count the usually sane Steven Pearlstein of the WaPo as one of those blood-thirsty fans who are cheering Guido the Kneecapper from the galleries (emphasis mine):

The creditors are right when they say that Obama offered a sweetheart deal to Chrysler's employees and retirees, who as unsecured creditors would have stood in line behind banks and hedge funds in a liquidation and would probably have received nothing. It's also true, as the unhappy creditors point out, that it was the above-market wages and benefits negotiated by the United Auto Workers that helped to bring Chrysler to the brink of bankruptcy in the first place.

But those arguments are really beside the point. If the U.S. government wants to lend billions of dollars to help save the jobs, pensions and health benefits of hundreds of thousands of workers, that is certainly its prerogative. And it doesn't have to extend the benefits of that bailout in equal measure to the banks and hedge funds that stupidly lent $6.9 billion to finance a highly leveraged buyout of a long-troubled automaker.

Shorter version: Screw the law, screw your contracts, screw what's fair and who's to blame — we won. Now Pappy Obama is gonna give and give to the UAW, using a combination of tax dollars (just a bit), deficit spending (quite a bit), and money that, by law and all the rules upon which our business system was built, should go to people who loaned money to Chrysler when no one else would, but on terms that were supposed to protect them from this kind of thuggery.

Disgusting. And tragic.

UPDATE (Sat May 2 @ 11:30pm): Megan McArdle asks a good question and makes a good point, but you'll have to decide for yourself whether they're naïve or merely rhetorical (h/t InstaPundit):

[W]hen did it become the government's job to intervene in the bankruptcy process to move junior creditors who belong to favored political constituencies to the front of the line? Leave aside the moral point that these people lent money under a given set of rules, and now the government wants to intervene in our extremely well-functioning (and generous) bankruptcy regime solely in order to save a favored Democratic interest group. [That's exactly the moral point Pearlstein, quoted above, honestly but eagerly discarded and then defecated upon. — Beldar]

No, leave that aside for the nonce, and let's pretend that the most important thing in the world, far more interesting than stupid concepts like the rule of law, is saving unions. What do you think this is going to do to the supply of credit for industries with powerful unions? My liberal readers who ardently desire a return to the days of potent private unions should ask themselves what might happen to the labor movement in this country if any shop that unionizes suddenly has to pay through the nose for credit. Ask yourself, indeed, what this might do to Chrysler, since this is unlikely to be the last time in the life of the firm that they need credit. Though it may well be the last time they get it, on anything other than usurious terms.

The reason I think they might be simply naïve is that unless the Obama Administration's desires and efforts are indeed checked by the disinfecting sunlight of the bankruptcy court and the rule of law, not even someone permitted (contrary to law) to lend money to Chrysler on usurious terms will do so. If the federal government can get away with stripping your creditors of all of their contractual protections — collateral-smatteral! hah! — to effect a massive transfer of wealth from them to the government's current favorites, then it doesn't matter if you're paying 50% or 150% interest per annum: No one will lend any money on any terms.

I'm wondering if Ms. McArdle (who I adore as a fine writer and a fine thinker, a libertarian economist of the first rank) is still laboring under the delusion that the Obama Administration gives a rat's patoot over the "long term" or the "integrity of the marketplace" or the "rule of law." Her point is entirely valid, just as it would have been entirely valid to lecture John Dillinger on how he and his loved ones would ultimately be better off living in a society whose would-be bank robbers restrained their inclinations and instead worked hard and invested for the long term. But valid doesn't mean effective, and that argument wouldn't have worked on Dillinger. It won't work on Guido the Kneecapper Obama either, because there are still massive amounts of loot yet to be redistributed from those who've earned it to those who merely want it (and can be relied upon to vote a straight Democratic ticket).

Doesn't Ms. McArdle understand? Obama won. If he and his friends at the UAW had any care for the long term and the national good, they wouldn't have methodically killed the golden goose that was supposed to fund all those pension and health care obligations in the first place.