Detroit’s angry lenders

The Obama administration is learning Robert Burns’ wisdom about “the best laid schemes o’ mice an’ men” the hard way as its plans to rescue Chrysler and General Motors meet commercial reality. The effort has been flawed from the outset. But once the political decision was taken that bankruptcy was not an option, two fundamental errors were made.

First, the administration and its Congressional allies repeatedly shifted the goalposts, giving the impression they would use taxpayer cash and their bully pulpits to seal a deal. This encouraged brinkmanship. Second, they favoured politically influential unsecured creditors, giving better terms to the United Auto Workers than to lenders or even taxpayers. Under GM’s offer, the UAW would get almost half the equity while noteholders, whose claims have legal parity, would get a fourth as much for debts more than twice as large. Meanwhile, Chrysler’s bank lenders were offered a third of face value, a worse deal than the UAW. Only banks receiving troubled asset relief programme aid agreed. Chrysler’s “non-Tarp” bank debt owners, mainly hedge funds, preferred bankruptcy.

Moral pressure was brought to bear. An administration official asked the non-Tarp group to “do the right thing” while a Michigan congressman urged them to “demonstrate a commitment to Main Street and the US industrial base”. Such entreaties should never override fiduciary duty. A bankruptcy judge could justifiably rule, for example, that acquiescent Tarp recipients had ulterior motives. GM’s bondholders, who rejected the offer, have a far stronger negotiating position in bankruptcy. They are also a more sympathetic group – mom and pop investors versus hedge funds.

Detroit’s politicised rescue may soon meet the cold legal reasoning of a bankruptcy judge, producing a more equitable outcome. It is a pity for taxpayers this did not happen earlier.

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