The Obama administration is creating the next future crisis. Their handling of the Chrysler situation is irresponsible, injudicious, and will have monstrous ramifications.
The President libelously scolded investment managers who owned Chrysler bonds for not taking the government's "deal". Some fund managers have even gotten death threats. Obama said the managers should "sacrifice like everyone else" and be "patriotic". Personally, I find this outrageous. Let me explain.
A buyer of a corporate bond is really just a lender of money to the company, who in return for his money receives a "fair" interest rate from the company. Bonds are safer than stocks, and, therefore, lower yielding, because if the company runs into problems the bond holder gets paid back first.
All investors understand that there is a clearly identifiable capital structure which dictates an investor's priority position to getting paid back. Anyone who lends money expects to be paid back. But, realizing there is the chance of default, a lender charges a certain interest rate that, in theory, compensates for the risk.
In a corporate bankruptcy, there are often plenty of assets left that can be sold to pay back lenders (bond holders) in the order of their capital position, so while the common stock may be worthless, bondholders typically get some money back.
Investors, such as hedge fund and pension managers, bought Chrysler Bonds on behalf of their clients. Every investment manager has a fiduciary responsibility to protect and invest their client's money to the best of their ability. The hedge fund manager did not accept the administration's "deal", plain and simply, because it was unfair, as they could have gotten much more in bankruptcy court.
Obama abused his power. He had no right to "steal" money from bondholders, and in turn, give it to the labor unions and then call the managers selfish. From what I have seen, hedge fund managers are typically some of the most philanthropic people in society. If you gave your money to a financial advisor, and rather than preserving your capital in a time of crisis, the advisor decided to "be patriotic" by giving it to a labor union, how would you feel? Would you be angry?
The Bush administration did something similar by stripping away the assets assigned to the senior secured bond holders of Washington Mutual, and then giving those assets to J.P. Morgan to help facilitate their takeover of the company. This horrendous decision served to exacerbate the financial turbulence last September. The decision turned the capital structure upside down, i.e., the common stock maintained value, while the senior most lenders were wiped-out. It resulted in a chaotic and broken financial market place.
Most market pundits blame the failure of Lehman brothers as the tipping point of market upheaval. I believe that the ignoring of Delaware corporate law and the decimation of the priority of the capital stock was the true catalyst which destroyed market liquidity, accelerated selling pressures, and made the rules of investing too unpredictable for rational investors.
The precedent being set by the government will have unintended consequences and serve to change the behavior of bond investors going forward and ultimately cause a crisis of significant proportion. You see, trillions of dollars of corporate, municipal and sovereign debt will mature and need to be rolled-over (re-issued) in the next several years. By changing the rules of investing and instilling questions as to the true state of the hierarchy of the capital structure pay back, investors will forever price risks differently. Rather than demanding, say, a 6% yield for a corporate bond, an investor may now demand 16%. Such a re-pricing will make debt servicing prohibitively too expensive for many businesses to raise capital and consequently have a deep negative effect on the broader economy. Unfortunately, those most in need of funds will be unable obtain them.
The ultimate result of the Chrysler mess will mean bankruptcy for many smaller businesses, an economy that cannot grow as fast as desired, and a less efficient capital market and one which has wider spreads between borrowers of different credit quality. Any person or company without impeccable credit will now find it difficult to find a loan at a reasonable rate. And tragically, if foreign investors start to question the depth and safety of our capital markets, September 2008 will look like a mere hiccup.