In announcing the collapse of negotiations to stave off a Chrysler bankruptcy filing, President Obama yesterday squarely blamed a "small group of investment firms and hedge funds" for the impasse. After commending the efforts of Chysler's management, the United Auto Workers, the Task Force of Autos and the substantial majority of lenders, he singled-out the hold-out creditors that were unwilling to accept the Government's offer to resolve approximately $6.9 billion of outstanding loans for $2.25 billion. In doing so, he chastised the recalcitrant lenders for failing to act in their own best interest and those of the other parties who had contributed and sacrificed to achieve a global resolution.
What Obama failed to mention is that the supposedly "unwilling" creditors consisted of 20 lenders owed $1 billion possessing the highest secured interest in Chrysler's assets and are first in-line to be paid in the event of liquidation. So, what Obama was really saying is that even if, in actuality, a not-so-small group of creditors negotiated an arm's-length lending arrangement with Chrysler granting it a superior right of repayment, such creditors should voluntarily relinquish that right because everyone else would be better off it they did. This is a shocking statement, fundamentally contrary to property and contract rights and to principles of capitalism and smacks of Western Europe's Socialist tendencies.
Let's take a basic "garden-variety" secured transaction for comparison's sake. A person buys a home or other piece of real estate, subject to financing. The lender, after reviewing the credit-worthiness of the borrower and the underlying assets to be financed, agrees to loan the balance of the purchase price secured by the property. In the event, the loan is paid according to the terms negotiated, the lender continues to receive payments during the life of the loan until satisfied in full. On the other hand, if the borrower is unable to make the required payments, the lender is able to foreclose its security interest in the property, become the owner of the property and to sell it to satisfy some or all of its remaining debt. Without such a financing mechanism, the vast majority of people would never be able to afford a home or only be able to purchase a home up to the amount of his available cash resources. In that instances, the value of real estate and the corresponding market would collapse due to a lack of qualified purchasers.
The same is true of commercial finance. Many borrowers would not be able to obtain loans to finance inventory, payroll and other operating expenses without granting a lender a security interest in its assets. Other loans may be made on an unsecured basis, but usually at a higher rate of interest than a secured creditor because of the increased risk of non-payment. Such lenders understand the increased risk is due to the fact that there is senior lender ahead of them that must be repaid before they receive anything. So, when Obama was complimenting the "majority of lenders" going along with a debt-reduction repayment plan, this was nothing more than pure political posturing. Essentially, Obama was complimenting lenders who agreed to receive more than they had otherwise initially negotiated to receive when making loans to Chryslers, being fully aware of their junior payment priority status. He, instead, chose to criticize the very lenders who negotiated for a higher priority of repayment in the event of default.
Why is this troubling? Because our entire commercial financing system is based upon a basic understanding of borrowers and lenders as to what rights they possess in the event of non-payment of a loan according to its contract terms. The lenders understand how they will be treated in relation to other lenders and price the risk via the interest rate charged on the loan plus any additional fees such as up-front points on a typical home mortgage. The borrower also understands that certain lenders have a priority right of payment and others may possess a lower priority security interest and still other may not possess any security at all for their loans. In the commercial world, as pointed out, these greater or lesser risks of repayment are priced according to relative risk.
Suggesting that the senior creditors agree to receive a lower amount than they would be entitled to in the event of liquidation or, worse yet, an amount equal to or similar to the rate of return of junior creditors, has no basis in the law. It was merely an attempt to demonize creditors for exercising their rights, where their rights were substantially superior to other lenders. Vilification should be reserved for unconscionable or abhorrent behavior fundamentally at odds with acceptable moral behavior, none of which is even remotely present here. It should be used even more rarely as a political tactic especially by The President of the United States.
We are a country of laws and for someone to exercise his rights, especially those rights no one has seriously challenged as of yet as valid, is alike to purposely poisoning a jury pool before a trial begins. This is not behavior to be celebrated; rather, it should be scorned. For if anyone is bludgeoned into foregoing his legitimate rights due to political pressure or for the betterment of the "whole", we are taking a great stride away from the premises upon which our legal and financial system depends.
While President Obama may have been disappointed in the outcome forcing Chrysler into bankruptcy court, a substantial portion of the work to reorganize the company has already taken place. He and his administration and the other parties contributing to those efforts should be praised. But, now is the time for the court to decide the legitimacy of the claims asserted by the unfairly castigated lenders. If they succeed in the end, they deserve an apology, not only because they will have been right but because they correctly resisted intimidation coming from the most powerful person in the world.
Whether the actions of these lenders will have adverse political consequences on hedge funds or the like in the form of increased regulation or tax policy should be judged on their merits. But it would truly unfortunate to penalize a group of individuals or entities simply because they chose to exercise their rights as every American citizen should feel equally free to do.
May 1, 2009 (Updated)
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