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Chrysler and How the Government Can Screw Up Capitalism

Prof. Peter Morici - 5/1/2009

Chrysler is teetering on Chapter 11, and the federal bailout illustrates how government efforts to rescue failing businesses often fall victim to crass political considerations.

Chrysler must persuade its bank creditors to swap what they are owed for common stock. That equity would have uncertain value, because the banks don’t know the final details of a new union contract governing wages, benefits and work rules. Also, they don’t know how many shares will be issued to the union for unfunded retiree health benefits and to Fiat for providing plans for new small vehicles. Hence, the banks can’t settle until they know the rest of the deal, but for their part, the union can’t settle on a new contract or shares to satisfy its claims, until it knows how many shares other stakeholders will get.

In Chapter 11, bankruptcy judges specialize in the rough justice of evaluating competing claims. According to the rules of primacy among creditors—for example, bank loans come before other creditors and any money owed the union for retiree health benefits—they impose a labor agreement and determine the allocation of shares in a new company.

The negotiating process orchestrated by the Obama Administration provides the clearest example of why politicians should stay out of bankruptcy proceedings and lemon socialism—propping up failing industrial enterprises like Chrysler while trying to mediate a new social contract.

If Chrysler went through Chapter 7 liquidation, its bank lenders could walk away with as much as 65 percent of what they are owed; because Chrysler has some of the most efficient manufacturing facilities in North America, even if it lacks decent vehicle designs to make in them, and the Jeep trademark is worth a great deal stamped on vehicles and other items, like toys and tee-shirts.

That 65 percent residual value would give Chrysler’s bank lenders enormous leverage in any Chapter 11 reorganization proceeding, and important consideration from the judge in awarding equity in a new Chrysler. Now, the Obama Administration wants to arbitrarily, and for political purposes, take away bank lenders’ leverage and those contractual rights.

The Obama Administration, inclined to pay off political debts to the UAW, is seeking to provide billions in cash to fund retiree health care benefits that the UAW would not receive in Chapter 7, and it is not at all clear that it is requiring the concessions from the UAW in a new contract necessary to make Chrysler a going concern. Meanwhile, the Obama team is offering Chrysler’s bankers only 22 percent of what they are owed plus 5 percent of the stock in a new Chrysler of highly questionable value.

Political considerations keep Obama’s team from imposing on the union the conditions necessary to make Chrysler viable, and it is using sovereign power to force the banks to take less than they are due to benefit the union.

The banks have trouble enough. They don’t need this kind of help from their government.