Coyote Blog

To me, the sub-prime auto loan market looks exactly like the home mortgage market in about 2006.

Back before 2009, Progressives were pushing like crazy to get banks to write mortgages to low-income borrowers with bad credit.  Banks that refused to do so would face the wrath of the banking regulators and lawsuits over redlining and ever other thing the Left could think of.   Seriously, if you had tried to stop sub-prime lending in 2006 the Progressives would have excoriated you as being racist, hating the poor, etc.  When the whole mess inevitably collapsed, the Progressives suddenly were there blaming this lending to low income people on the banks, accusing them of predatory lending practices.

OK, so now it is 2006 in the consumer credit market, and specifically in auto loans.  Banks are making crap loans to no-credit individuals on cars and getting them off the books by securitization.   So let's get Elizabeth Warren on the record right now.  Should banks stop lending to these no-credit low-income people?  My bet is that she would support this lending, doubly so because the Obama Administration feels on the hook still for their GM and Chrysler bailouts and would rather not see these companies tank (which they would if sub-prime credit suddenly dried up).  So, before she can piously accuse banks of predatory practices 3 years hence when it all collapses, I want to know what Elizabeth Warren thinks of all this right now.

Update:  Well, good news and bad news.  Good news is that Elizabeth Warren has criticized sub-prime auto.  Bad news is she appears to be totally on the wrong track with causes, talking not about the fact the loans should not be written at all but about the fact that she thinks dealers are reaping huge profits marking up the loans.  It would be interesting to see what the Obama Administration would think about a clamp-down on sub-prime auto.  Methinks they might freak out at that, knowing sub-prime loans are all that is keeping US automakers out of a new recession.

I followed a link the other day to this academic paper purporting to show that the bailout of GM and Chrysler was a success.  I was flabbergasted to see that the authors are Austan D. Goolsbee and Alan B. Krueger.  WTF?  These folks were part of the Obama Administration.  This is their own policy they are passing historical judgement on.  This is roughly equivalent to a economics journal seeking a paper on the success or failure of Obamacare and having Valerie Jarrett write it.  How does this kind of conflict of interest pass any kind of muster?

I only skimmed the paper.  I know these are two smart guys but it seems to include exactly the sort of facile analysis you would expect from a political hack, not two smart economists.  I can't believe these guys would have accepted many of the assumptions they make here had they not been directly involved.  Just to pick two things at random:

• They seem to stick with the assumption that millions of jobs would have simply gone *poof* had the government not intervened.  Yes, this happened at Solyndra, but in most cases industries operate almost seamlessly in bankruptcy.  The odds are, for example, that you have flown on an airline in Chapter 11 and didn't even know it.  They make a specific argument that somehow it would be bad to have both in bankruptcy at the same time, but I can remember several times when there were multiple major airlines in bankruptcy.  In fact, if both went bankrupt at the same time, one could argue it would lessen their market share loss since a major competitor was in the same boat.  To the extent that the companies would have continued to operate under Chapter 11, which is 99.9% likely, then all the government did was insert itself into the bankruptcy process to overrule laws about who gets what in a bankruptcy to redirect spoils to their favored constituencies
• Yes, GM and Chrysler are doing OK now, but they usually do OK at the top of a business cycle.  To my eye though, nothing fundamentally changed about how they are managed and operate.  The same structural and cultural problems that existed before exist today.  The same under-utilization of talented workers and valuable assets that existed before exists today.  No real reckoning occurred -- in fact the bailout looked to me at the time as an exercise to use taxpayer money to avoid a true housecleaning.  These companies have done OK, but what would they have done with a more thorough housecleaning?

Last week, I noted a piece by Steve Rattner who was horrified that individual investors, empowered by companies like Kickstarter, might one day be able to invest in startups without paying a fee to Goldman Sachs.

I noted that Mr. Rattner's concern for investors seemed to be coming rather late, given that "he was the primary architect of the extra-legal screwing of GM and Chrysler secured creditors in favor of the UAW and other Obama supporters."

A Detroit News piece by my Princeton classmate Henry Payne has more:

The administration has treated obstacles to its agenda with ruthless tactics. In April 2009, that agenda was to hand an outsized, 55 percent majority interest of embattled Chrysler to the United Auto Workers in a government-orchestrated bankruptcy. But by law secured creditors are first in line in bankruptcy, and bondholders — representing their working-class pension clients — refused to accept Obama's unfair deal for a measly 29 cents on their investment dollar.

Send in the muscle.

"One of my clients was directly threatened by the White House and in essence compelled to withdraw its opposition to the deal under threat that the full force of the White House press corps would destroy its reputation if it continued to fight," said Tom Lauria, lawyer for Perella Weinberg investment firm, on Frank Beckmann's Detroit radio program. Lauria later said the brass knuckles belonged to White House Auto Task Force leader Steve Rattner. Lauria's account was disturbing, too, in revealing the confidence that the White House has in its press allies to aid Obama's agenda. Sure enough, Washington reporters quickly attacked the messenger. "(Lauria's) charge is completely untrue," White House deputy press secretary Bill Burton told ABC News' Jake Tapper, "and there's obviously no evidence to suggest that this happened in any way." Actually, there was plenty of evidence. Jim Carney of Business Insider corroborated Lauria's account, reporting that "sources familiar with the matter say that other firms felt they were threatened as well." The White House escalated the threats when Obama himself singled out creditors for obstruction, accusing them of being "speculators" preying on an American auto icon — bullying words from a man with the IRS and SEC at his disposal.

"The sources, who represent creditors to Chrysler, say they were taken aback by the hardball tactics that the Obama administration employed to cajole them into acquiescing to plans to restructure Chrysler," continued the Insider. "One person described the administration as the most shocking 'end justifies the means' group they have ever encountered."...

"The president's attempted diktat takes money from bondholders and gives it to a labor union that delivers money and votes for him," wrote Cliff Asness, a managing partner at AQR Capital Management. "Shaking down lenders for the benefit of political donors is recycled corruption and abuse of power."

Steven Rattner, investment banker and former member of the Obama Administration,  is terrified that under a proposed law companies will be able to raise money without investment bankers.

Most troublesome is the legalization of “crowd funding,” the ability of start-up companies to raise capital from small investors on the Internet. While such lightly regulated capital raising has existed for years, until now, “investors” could receive only trinkets and other items of small value, similar to the way public television raises funds. As soon as regulations required to implement the new rules are completed, people who invest money in start-ups through sites similar to Kickstarter will be able to receive a financial interest in the soliciting company, much like buying shares on the stock exchange. But the enterprises soliciting these funds will hardly be big corporations like Wal-Mart or Exxon; they will be small start-ups with no track records.

This is absolutely, classically representative of the technocratic arrogance of the Obama Administration and the investment bankers that inhabit it.  I have three quick thoughts:

1. Rattner's concern for individual investors comes rather late.  After all, he was the primary architect of the extra-legal screwing of GM and Chrysler secured creditors in favor of the UAW and other Obama supporters.
2. God forbid investors get actual, you know, ownership in a company for their capital rather than just trinkets.  This is so bizarrely patronizing that I had to read it twice just to make sure I wasn't missing something.  But no, he is explicitly preferring that you and I get trinkets rather than ownership  (ownership, apparently, to be reserved for millionaire insiders like himself).
3. We have truly entered the corporate state when leftish opinion makers argue that large corporations like Exxon and Wal-Mart get preferential access to capital and that smaller startups that might compete with them be shut out of the market.

I predict that over that Internet entrepreneurs running such crowd-sourcing sites would develop reputation management and review tools for investors (similar to those at Amazon and eBay).  Over time, it may be that these become far more trustworthy than current credit agency reports or investment bank recommendations.  After all, which do you trust more -- a 5-star Amazon review with 35 responses or a Goldman Sachs "buy" recommendation on an IPO like Facebook or Groupon?  Besides, it would take a very long time, like eternity, for fraud losses in a crowd-sourcing site to equal 1/100 of the investor losses to heavily regulated Bernie Madoff.

I do not agree with Mitt Romney's implied protectionism in his ads, particularly when he says

Obama took GM and Chrysler into bankruptcy and sold Chrysler to Italians who are going to build Jeeps in China

The problem with Obama's intervention in the GM and Chrysler bankruptcies was cronyism -- the protection of favored insiders to the detriment of the operation of the rule of law -- rather than any accelerated globalization.  The auto industry is a global business, deal with it. We should be thrilled that Chrysler is participating in the Chinese economy, an opportunity they would not have had a generation or two ago.  This kind of populist BS is exactly why I voted Johnson, not Romney, this morning.

Anyway, this statement has been subject to a lot of "fact-checking."  Chrysler head Sergio Marchionne wrote a letter in the Detroit News, and while he did not attempt to deny the part about Italians (though that would have been funny), he did write:

Chrysler Group's production plans for the Jeep brand have become the focus of public debate.

I feel obliged to unambiguously restate our position: Jeep production will not be moved from the United States to China.

OK, thanks for the clarification.  But wait, the letter goes on.  He spends a lot of time explaining how Chrysler is investing a lot in Jeep SUV development and production, and that many jobs are being added making Jeeps.  In fact, Jeep SUV's seem to be the big bright spot in the Chrysler turnaround, which is funny because Obama's logic for handing Chrysler over to Fiat for about a dollar was that Fiat would turn Chrysler around with all of its great small car designs.

Anyway, the really interesting part comes late in the article, where he says in paragraph 9:

Together, we are working to establish a global enterprise and previously announced our intent to return Jeep production to China, the world's largest auto market, in order to satisfy local market demand, which would not otherwise be accessible.

So Chrysler ... is going to build Jeeps in China.

This is why the whole "fact check" genre is so stupid.   We could fact-check this three ways, depending on what political axe we want to grind:

1. We could say that Romney's ad was exactly correct, that Chrysler's CEO says it is going to build Jeeps in China, just as Romeny said.  Romney's statement is literally true as written, which one would think might be a good criteria for a fact-check.
2. We could say that Romney's ad was misleading, because the implication was meant to be that Chrysler is shifting North American production to China, and they are not (Politifact took this tack).
3. We could argue that Romney's entire premise is wrong, because what matters to long-term economic health and wealth creation in this country is that Chrysler is making the optimum production decisions, wherever the factories end up.  And further, that making these decisions the subject of political discourse virtually guarantees they will be made for reasons other than optimizing efficiency.  This is the fact-check I would make but you will not hear in mainstream media fact-checks, because the level of economic ignorance on trade in most of the media is simply astonishingly high.

Companies and assets don't go *poof* in a bankruptcy.   In fact, if any of you are even somewhat of a frequent airline flyer, over the last 10 years you likely flew an airline in bankruptcy.  Companies operate all the time, sometimes for years, out of Chapter 11.  In fact, that is what chapter 11 is all about -- helping creditors get more value from a company by keeping it in operation  (only in truly hopeless cases, like Solyndra, is liquidation a higher value outcome for creditors than continued operation).

As such, then, the Obama Administration did not "save" GM and Chrysler, it simply managed their bankruptcy to political ends, shifting the proceeds from those guaranteed them by the rule of law to cronies and political allies.  In the process, they kept these companies on essentially the same path that led them to bankruptcy in the first place, only with a pile of taxpayer money to blow so they could hang around for a while.

To this end, the WSJ has a great editorial on the whole mess

In a true bankruptcy guided by the law rather than by a sympathetic, rule-bending political task force, GM and Chrysler would have more fully faced their competitive challenges, enjoyed more leverage to secure union concessions, and had the chance to divest money-losing operations like GM's moribund Opel unit. True bankruptcy would have lessened the chance that GM and Chrysler will stumble again, a very real possibility in the brutally competitive auto industry.

Certainly President Obama threw enough money at GM and Chrysler to create a short-term turnaround, but if the auto makers find themselves on hard times and return to Washington with hats in hand, his policy will have been no rescue at all.

I will refer the reader back to my editorial way back in 2005 why it was OK to let GM die

I work in a small, four-story suburban office building.  I have seen our fire drills and can look out at our parking lot, and I would be surprised if there are 200 people in the building.    A few months ago some division of Chrysler moved in and took a bunch of the space.   A lot still remains empty (which is why I am here -- cheap!)

The Chrysler folks put a sign downstairs a few days ago saying that they would be hosting a luncheon for the building.  Great, I thought, a free hot dog and some fruit salad.  Imagine my shock when I saw this when I arrived today:

Chrysler sent three full semi-trailers, one of cars and two of convention-type booths and displays, plus a whole crew of people to set this up, all for a lunch in our building with less than 200 people.  I thought maybe that we were just getting a preview of a larger public event, but I am looking out my window now and they are tearing down again.  Crazy.

One thing that even many libertarians get wrong:  Wasting money is not unique to government entities.  Private and public entities can become senescent, and grow bureaucracies that lose focus on what they are supposed to be doing.  The difference between the private and the pubic sphere, though, is that for private companies, markets eventually enforce discipline (either forcing change or killing off the bloated entity).   There is no similar mechanism for state agencies short of perhaps absolute bankruptcy, and Greece is proving even that is not enough to force change.

Of course, when the government gives large private entities with political pull special protections and bailouts, then no such accountability is enforced.  The same people are operating the company with the same false assumptions and unlearned lessons.

I will leave aside the issue of the recently revealed massive loans from the Fed to various banks.  It can be argued that being the provider of last resort for short-term liquidity in the banking system is a legal, even legitimate, role for the Fed.

But scan this list.  Here are some of the "banks" that got close near-interest-free money from the Fed

• Verizon
• Chrysler
• Caterpillar
• Harley-Davidson
• Baxter International

I presume these loans were nominally for their financing arms, but what is the systematic-risk argument for backstopping manufacturer's credit operations?

When I was at McKinsey & Co, part of their relocation package was a $10,000 interest-free one year loan.  I had any number of new recruits say they did not need the loan.  I told them it was a business IQ test.  If you turned down the loan, we revoked your job offer (just kidding, of course).  I took the loan and dropped it into T-bills.

I wonder how many of these recipients really needed the money to survive or just got smart enough to claim dire need and took the money and just dropped it into something interest-bearing.

In my Forbes column this week, I publish an essay I wrote for an Americans for Prosperity event commemorating Milton Friedman's birthday.  A brief excerpt:

Having once been successful through excellence, leading businesses typically get lazy and senescent, and become vulnerable to more innovative, lower-cost or more nimble new competitors.  Sears lost its electronics sales to Circuit City, which in turn succumbed to Best Buy, which is now struggling to compete with Wal-Mart, who is being challenged by Amazon.com.

Unfortunately, businesses that were once successful can feel a sense of entitlement, believing that this new competition is somehow unfair, or that consumers are somehow misguided in taking their business elsewhere.  When they have money or political connections, these businesses may run to Congress and beg for special protections against competition, or even new subsidies, mandates, stimulus projects, and bailouts.

Where is the threat to capitalism and individual liberty coming from today?  Is it from some aggrieved proletariat, or is the threat from bailed out Wall Street firms, and AIG, and GM, and Chrysler, and ethanol manufacturers, and electric car makers, and windmill builders?

 

Todd Zwicki has a great article on the auto bailouts.  Here is a brief excerpt of a long and very comprehensive article.

Of the two proceedings, Chrysler's was clearly the more egregious. In the years leading up to the economic crisis, Chrysler had been unable to acquire routine financing and so had been forced to turn to so-called secured debt in order to fund its operations. Secured debt takes first priority in payment; it is also typically preserved during bankruptcy under what is referred to as the "absolute priority" rule — since the lender of secured debt offers a loan to a troubled borrower only because he is guaranteed first repayment when the loan is up. In the Chrysler case, however, creditors who held the company's secured bonds were steamrolled into accepting 29 cents on the dollar for their loans. Meanwhile, the underfunded pension plans of the United Auto Workers — unsecured creditors, but possessed of better political connections — received more than 40 cents on the dollar.

Moreover, in a typical bankruptcy case in which a secured creditor is not paid in full, he is entitled to a "deficiency claim" — the terms of which keep the bankrupt company liable for a portion of the unpaid debt. In both the Chrysler and GM bankruptcies, however, no deficiency claims were awarded to the wronged creditors. Were bankruptcy experts to comb through American history, they would be hard-pressed to identify any bankruptcy case with similar terms.

To make matters worse, both bankruptcies were orchestrated as so-called "section 363" sales. This meant that essentially all the assets of "old Chrysler" were sold to "new Chrysler" (and "old GM" to "new GM"), and were pushed through in a rush. These sales violated the longstanding bankruptcy principle that an asset sale should not be functionally equivalent to a plan of re-organization for an entire company — what bankruptcy lawyers call a "sub rosa plan." The reason is that the re-organization process offers all creditors the right to vote on the proposed plan as well as a chance to offer competing re-organization plans, while an asset sale can be carried out without such a vote.

In the cases of GM and Chrysler, however, the government essentially pushed through a re-organization disguised as a sale, and so denied the creditors their rights. As the University of Pennsylvania's David Skeel observed last year, "selling" an entire company of GM or Chrysler's size and complexity in this manner was unprecedented. Even on a smaller scale, it would have been highly irregular: While rush bankruptcy sales of much smaller companies were once common, the bankruptcy laws were overhauled in 1978 precisely to eliminate this practice.

At first, the fact that the companies' creditors (and especially Chrysler's creditors, who were so badly mistreated) put up with such terms and waived their property rights seems astonishing. But it becomes less so — and sheds more light on how this entire process imperils the rule of law — when one considers the enormous leverage the federal government had over most of these creditors. Many of Chrysler's secured-bond holders were large financial institutions — several of which had previously been saved from failure by TARP. Though there is no explicit evidence that support from TARP funds bought these bond holders' acquiescence in the Chrysler case, their silence in the face of a massive financial haircut is otherwise very difficult to explain.

Indeed, those secured-bond holders who were not supported by TARP did not go nearly as quietly.

Great post from SM Oliva via Tom Kirkendal at Houston Clear Thinkers.  They both make a point I have been making for years -- that the large growth of major sports team revenues and player salaries is attributable, in large part, to enormous public subsidies

The NFL encapsulates, perhaps better than any other single business entity, the popular conceptions -- and misconceptions -- about capitalism and the nature of markets. The league is the epitome of statist "crony" capitalism. Its franchise operators demand huge government subsidies for stadiums while jealously guarding its prerogatives as a "private" business. Governments (and their media enablers) largely go along with this because they've been led to believe the NFL's popularity is so immense that no respectable city can go without a franchise.

Professional football is the ethanol of the entertainment industry. Since 1990, nearly every NFL franchise has either opened a new stadium, made substantial renovations to existing stadiums, or is currently in the process of obtaining a new stadium. Over this 20-year period the league's franchises obtained over $7 billion in taxpayer subsidies raging from direct taxes to publicly backed bonds. Ten stadiums are 100% government-financed, while another 19 are at least 75% government-financed. Every single franchise receives some amount of government subsidies.

Here is a great way to think about it -- many new NFL stadiums cost in the one billion dollar range.  That is a billion dollars for a building that is used 3 hours per day for 10 days a year (8 regular season and 2 preseason games).  A billion dollars for a building with 0.3% occupancy.  How can a private entity afford such an investment and still pay multi-million dollar salaries to their employees?  They can't.  Which is why you and I as taxpayers are so often on the hook for the costs.

Heck, here in the Phoenix area, we are hundreds of millions of dollars in the tank for a for-god-sakes hockey team, and about to spend hundreds of millions of more to support it.

Update: This reminds me of my Forbes article on triumphalism and large building projects

Mark Thornton of the Mises Institute wrote a few years ago about the “skyscraper index,” a correlation first studied by economist Andrew Lawrence, which purports to connect downturns in the business cycle with the construction of the world’s largest skyscraper. Thornton did not suggest the “skyscraper index” was an infallible predictor of economic downturns, but there was ample empirical evidence to suggest “the cause of skyscrapers reaching new heights and severe business cycles are related to instability in debt financing and that the institutions that regulate debt financing should be reevaluated, if not replaced with more efficient and stabilizing institutions.”

Cowboys Stadium may prove to be the NFL’s version of the Chrysler Building, where the groundbreaking occurred a month before the stock market crash of 1929. By most accounts “Jerry World” is the most opulent, luxurious stadium ever built for an NFL team. Not surprisingly, it is also a debt-ridden project that exists only because Jerry Jones had easy access to a government-backed credit card.

After famously throwing out 200 years of bankruptcy law to hose secured creditors in favor of uni0ns at GM and Chrysler, the Obama Administration is again bailing out the unions that helped get him elected

Barely 15 percent of all construction-industry workers in the United States are union members, while the remaining 85 percent are nonunion, according to the U.S. Department of Labor's Bureau of Labor Statistics. So why has President Obama signed Executive Order 13502 directing federal agencies taking bids for government construction projects to accept only those from contractors who agree in advance to a project labor agreement that requires a union work force? Obama's new order applies to all federal construction projects with price tags of $25 million or more, and it means all such contracts will only be awarded to companies with unionized work forces.

The costs of this to the public are pretty obvious, not only in terms of fairness but in increased costs and reduced competition.

Another factor helps explain Obama's willingness to sign an executive order that will put millions more tax dollars in union coffers. Mix points out that unions under PLAs typically exact agreements that include requiring contractors to make payments to union pension funds. This is an increasingly urgent issue, as the Washington Examiner's Mark Hemingway has recently detailed in these pages. According to Labor Department filings, the average union pension has only enough money on hand to cover 62 percent of the benefits it has promised to union members. Pension plans with 80 percent funding are considered "endangered" by federal auditors, while those with less than 65 percent funding are put on the "critical" list. With this latest executive order, it's clear that Obama intends to give unions on the critical list a massive dose of federal tax dollars to cure what ails them.

I'll keep saying it - this is right from the playbook of the European-style corporate state.

One of the perils of being a populist, as John McCain is finding out, is that the public is allowed to change its mind, but politicians who attempt to follow them end up looking bad.

the four-term senator says he was misled by then-Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke. McCain said the pair assured him that the $700 billion Troubled Asset Relief Program would focus on what was seen as the cause of the financial crisis, the housing meltdown.

"Obviously, that didn't happen," McCain said in a meeting Thursday with The [Arizona] Republic's Editorial Board, recounting his decision-making during the critical initial days of the fiscal crisis. "They decided to stabilize the Wall Street institutions, bail out (insurance giant) AIG, bail out Chrysler, bail out General Motors.... What they figured was that if they stabilized Wall Street - I guess it was trickle-down economics - that therefore Main Street would be fine."

I am not sure this is much of a defense.  Even without McCain's access to such financial luminaries, I and many others predicted at the time the $700 billion slush fund would be used as, well, as slush fund to bail out the politically well-connected.  I must admit I didn't see the GM/UAW bailout coming, but its not wildly surprising in retrospect.

Unfortunately for all of us, McCain's competition in the next election, JD Hayworth, is even less appealing.

I argued last week that all the electric vehicle talk we heard so much of at Chrysler and GM during their restructuring (remember all those GM electric car ads on TV, which have now disappeared?) were just a honey trap for Obama.  Auto makers knew that they were not designing a car for the masses, but for one man, to get him to put taxpayer money into their companies.  Now that they actually have to think about selling these cars to the public, the ads have disappeared and now Chrysler is ending its EV program.

I want to take you back to their restructuring plan.  The plan had 7 steps, listed in priority order.  The first and second priority was restructuring.  The third priority was a deal with Fiat.  The next priority, ahead of any others beyond the initial restructuring and Fiat deal, was their EV car program.  Here is the page from their plan (click to enlarge)

In fact, this was very clearly a business plan aimed at Obama.  Look at the #4-7 priorities and their order.  Only one potential investor in the whole world would appreciate these priorities.  Any private investor would find these priorities nuts:

4) Commitment to Energy Security and Environmental Sustainability

5) Compliance with Fuel Economy Regulations

6) Compliance with Emissions Regulations

7) Achieving a Competitive Product Mix and Cost Structure

So "achieving a competitive product mix and cost structure," arguably the problem that drove them into bankruptcy, is their dead last priority!  Welcome to government motors, where commitment to energy security is more important than having a competitive product mix or cost structure.

Those of us who accused Chrysler and GM of hyping their electric car programs merely as a honey trap to capture money from the Obama Administration were accused of being ridiculous cynics.  But...

Chrysler has disbanded a team of engineers dedicated to rushing a range of electric vehicles to showrooms and dropped ambitious sales targets for battery-powered cars set as it was sliding toward bankruptcy and seeking government aid.

The move by Fiat SpA marks a major reversal for Chrysler, which had used its electric car program as part of the case for a $12.5 billion federal aid package.

As late as August, Chrysler took $70 million in grants from the U.S. Department of Energy to develop a test fleet of 220 hybrid pickup trucks and minivans, vehicles now scrapped in the sweeping turnaround plan for Chrysler announced this week by Fiat CEO Sergio Marchionne.

I don't know if you remember, but during the GM bankrupcy deliberations, the airwaves were flooded with commercials for the Chevy Volt.  Seen one lately?  It is clear in retrospect those messages were political ads seeking subsidies, not marketing ads seeking to sell cars.

This is an interesting video from the State Treasurer of Indiana about his state's experience as a secured creditor of Chrysler, and how their legal claims were pushed aside as the Administration moved more politically-favored constituencies (e.g the UAW) ahead of the secured creditors in line.

One side issue here.  Early in the video he explains that the State of Indiana held a lot of Chrysler bonds because Chrysler is a big employer and they try to support companies with a big footprint in the state.

Isn't that terrible risk management policy, closely akin to Enron employees putting all of their savings in Enron stock?  If Chrysler goes down, this means loss of investment returns in key retirement funds at the same time there is a large loss of tax money that will likely be the source of replacement funds.

Apparently, Chrysler is toast.  Which is what a lot of us were saying before taxpayers put billions of dollars into it.  (ht:  Maggies Farm)

Rumors, credible rumors, are beginning to circulate in the car industry and the automotive press, that Chrysler may not make it another year primarily due to its falling sales and growing financial losses at partner Fiat....

The Congressional Oversight Panel has already said taxpayers will not see most of the $81 billion that they put into the American car industry. The $14.3 billion put into Chrysler is more and more likely to be lost completely. The biggest single loser if Chrysler cannot survive is the UAW which owns 55% of the company.

I struggle to cry much for the UAW with that last part.  They only own 55% because the President intervened to give what should have belonged to the secured credit holders over to the UAW in exchange for being so helpful in getting him elected.

In January 2009, Chrysler stood on the brink of insolvency.  Purporting to act under the Emergency Economic Stabilization Act, the Treasury extended Chrysler a $4 billion loan using funds from the Troubled Asset Relief Program (TARP).  Still in a bad financial situation, Chrysler initially proposed an out-of-court reorganization plan that would fully repay all of Chrysler's secured debt.  The Treasury rejected this proposal and instead insisted on a plan that would completely eradicate Chrysler's secured debt, hinging billions of dollars in additional TARP funding on Chrysler's acquiescence.

When Chrysler's first lien lenders refused to waive their secured rights without full payment, the Treasury devised a scheme by which Chrysler, instead of reorganizing under a chapter 11 plan, would sell its assets free of all secured interests to a shell company, the New Chrysler.  Chrysler was thus able to avoid the "absolute priority rule," which provides that a court should not approve a bankruptcy plan unless it is "fair and equitable" to all classes of creditors.

I had more here.

Update: A firsthand account from a hosed secured creditor (pdf)

Details of the bankruptcy were unprecedented. For the first time in American history and totally counter to all established laws of bankruptcy, secured creditors would receive less than nonsecured creditors....

Indiana's legal filings in the Chrysler, LLC bankruptcy sale made three essential points: First, the bankruptcy laws which have been in place protecting the rights of secured creditors cannot be arbitrarily overthrown by an act of the Executive. This is a violation of Article I, Section 8 of the U.S. Constitution in that Congress is solely assigned the role to determine uniform bankruptcy law. Neither the Courts nor the Executive can do this arbitrarily. Our funds suffered a "taking" in violation of the Fifth Amendment in that there was no "due process of law". There was, and is in all financial arrangements between debtor and creditor, a contractual relationship, which is here being rendered null and void. If allowed to stand, this violation of two party contracts undermines a basic and essential tenet of debt financing in the capital markets.

Second, money provided by the federal government to Chrysler is being provided illegally and clearly counter to the intent of Congress. When TARP was being debated then Secretary of the Treasury Henry Paulson testified the money was NOT for the auto companies. It was targeted to aid the ailing financial industry, i.e, those with "Troubled Assets" that needed a "Recovery Program." Evidence that the money was NOT intended to be an automotive bailout bill could not be more clearly illustrated than to review the failure of the separate automobile bailout bill presented in Congress in December 2008. If Congress had intended the TARP bill to cover the auto companies when it passed in October 2008, why were they even attempting to pass a separate automobile bailout bill just two months later? We believe both the Bush and Obama administration have acted illegally in this use of TARP funds.

Third, we argue that a sub rosa or "under-the-table-arrangement" between the Treasury and Chrysler prevented a fair valuation of the assets. In a legitimate auction sale, no potential bidder would be allowed to set the value of the assets being auctioned. But that is precisely what happened in this case as the Treasury was assigning values to creditors, determining which assets would be liquidated, what new parties, (i.e., Fiat SpA), would be brought into the deal, and how a new dealership network would be defined, etc. It was known from the outset that when the Chapter 11, Section 363 sale of the assets would occur, there would be only one bidder: the U.S. Treasury. Secured creditors could not have their rights protected or fairly valued in such an arrangement. Such an "insider-deal" reeks of impropriety.

I have not blogged much in the last week on the Obama takeover of GM, but you can take all my old Chrysler posts and just substitute "GM" for "Chrysler" and you will have it pretty much straight.   Having gotten away with hammering secured creditors in favor of the UAW at Chrysler, Obama is setting the same course at GM.  Via Q&O:

The United Auto Workers retiree health fund is set to own as much as 39 percent of the restructured GM, in exchange for giving up its claim to at least $10 billion that the company owes it....

The chief obstacle to an out-of-court settlement for GM remains: There has been no agreement between the company and the investors who hold $27 billion worth of GM bonds.

Under orders from the Obama administration, GM has offered to give the bondholders a 10 percent equity stake in the restructured company in exchange for giving up their bonds.

Hmmm...  let's give unsecured creditor the UAW a 10x better deal than the secured creditors.  No wonder Obama wants to keep this out of bankruptcy court -- laws and contracts and stuff actually would have to be applied there.   But the company will be set for the future -- the US and Canadian governments will control a majority of the board seats, with the rest presumably controlled by the UAW.  Does everybody believe me now when I say we are heading toward a European-style corporate state?

The only thing standing in the way, of course, is those pesky secured creditors, who are actually holding out for what they are legally and contractually due.   Obama's got a bit more difficulty here at GM than at Chrysler because a smaller percentage of the secured creditors are TARP recipients, and therefore he has less leverage to make them give up their rights  (at Chrysler, the TARP majority was pressured successfully into selling out their non-TARP brethren among the creditors).

Of course, Obama has the advantage of Chrysler as a precedent, which makes it pretty clear why he set Chrysler up as the first to be intimidated, as he had the most leverage over them with TARP recipients in the creditor group.  Interestingly, this is very similar to how the UAW has always dealt with the Big 3, targeting the most vulnerable for pressure in contract talks, and then using that settlement as a precedent in the rest of industry.  One wonders if the UAW hasn't been whispering in his ear through this whole process.

I had a question the other day:  Why is closing dealerships a cost savings for Chrysler?  My understanding is that dealers were independently-owned businesses that bought inventory from the manufacturer, and then sold and serviced the cars.

I came up with only two answers:

1. Auto makers finance dealer inventory in some way (either as financing or putting the inventory on consignment) such that cutting back on dealers cuts back on financing needs.  Yes, with fewer dealers, the others are likely to need more inventory, but basic inventory theory says the total in the system will still be less with fewer outlets.  Also, they might preferentially cut weaker dealers more likely to need financing in favor of larger dealers who can self-finance
2. Having too many dealers competing against each other with the same product undermines pricing in the market.  Dealers cut pricing to the bone in order to get the servicing income stream after the sale.  While this should not directly affect the pricing to the manufacturer, it might be argued that retail discounting is a negative for the brand over time  (electronics manufacturers have debated this point for years, and there is certainly no consensus on this).

Megan McArdle provides her own answers to this question, some similar and some different:

A number of readers have asked a simple, obvious question:  why do the dealers cost Chrysler so much money that they want to shut them down?  I don't have a complete answer to it, but here's what I understand:

• Inventory:  Chrysler often has to take back unsold inventory.  A lot of dealers selling a little inventory is costly, because you have to ship a minimum number of cars to each dealer
• Financing:  Chrysler helps many dealers float their purchases (though to be fair, those dealers also tap their own credit for things like advertising, expanding the company's effective spending)
• Brand costs:  Shabby, run-down dealerships don't improve the image of the firm, and if they are the only game in town, drive users to other cars.

She follows with a good analysis of why independent dealers exist in the first place.

It will be interesting to see how this goes down.  Frequent readers will know that I often have said that the power base of many small-medium size towns is made up of 1) the auto dealers, 2) the beverage wholesalers and 3) the owners of the local TV stations and newspapers.  Auto dealers wield a lot of local political power - they are often the largest single financial supporter of local politicians and even some Congressional reps.  They also wield power as typically the largest single advertiser in local media, so they get sympathetic coverage.  Over the years, they have translated this into a lot of legislative help (such as limitations on Internet competition).

Via Zero Hedge:

A group of Chrysler creditors opposing the carmaker's reorganization is likely to disband after two more investment firms withdrew from its membership, a person briefed on the matter told DealBook on Friday.

The withdrawals of OppenheimerFunds and Stairway Capital Management will likely drop the group, calling itself the Committee of Non-TARP Lenders, below 5 percent of Chrysler's $6.9 billion in secured debt, this person said. That would almost certainly eliminate the group's standing in federal bankruptcy court.

Ever since the group made public last week, its membership has shrunken by the day as it faced public criticism from President Obama and others. That continued withdrawal of firms led Oppenheimer and Stairway to conclude that they could not succeed in opposing the Chrysler reorganization plan in court, the two firms said in separate statements.

Just another step closer to a Mussolini-style corporate state.

Update: David Skeel argues the Chrysler bankruptcy settlement is a sham sale of the sort that was outlawed in 1938.  Except, of course, when the President does it, I guess.

Finem Respice has a great post on the Administration's bare-knuckle tactics in trying to enforce its will (against the dictates of bankruptcy law) on Chrysler:

It should be obvious to most observers that, recent allegations of strong-arm tactics in negotiations with Chrysler creditors notwithstanding, given the current situation the White House shouldn't need to resort to anything so openly thuggish as naked threats issued by the likes of Steven Rattner. Assuming for a moment, and for the purposes of conversation, that the allegations are substantially true (and I believe they are), the fact that a bit of Chicago-style thuggery seems to have been required- and seems to have failed- says a lot about this White House. It also says quite a bit about the wild overconfidence intrinsic in the administration and how entirely unused to being denied their will are the senior members thereof. A more deft executive need not have pushed so hard, or rattled the saber of class warfare so loudly, but then a more deft executive would not have expected so much....

There are three things that are scarier than the actual resort to common thuggery. The ease with which it comes to this administration. The ubiquitous and rank ineptitude that makes a resort to thuggery necessary in the first place- and promises it will become a common tactic in the days to come. And the forgiveness the population regularly affords the administration after one or another of these episodes is, yet again, made public.

The tantrums that follow missed targets sketch an interesting family portrait of a class of politically spoiled children, think Hillary Clinton meets Paris Hilton- totally devoid of real executive experience but somehow still used to getting their way no matter what some silly law book says. I believe I'll take my chances with the "speculators" over these alternatives any day, particularly when the spoiled children have the 82nd Airborne Division in their toy chest.

When Obama, who has no real experience with bankruptcy or really with any business enterprise, attempts to substitute for a bankruptcy judge, we have to ask ourselves why.  He certainly does not have as much experience or expertise.  He has no particular unique knowledge of the business.  The only unique "quality" Obama has that a bankruptcy judge does not is that Obama does not feel bound by bankruptcy law.   The only possible reason for his involvement is to substitute his desired outcome for the one that would result from the normal application of contract law and bankruptcy precedents.  Since this is an inherently political process, it should not be surprising that at its core, Obama's actions are meant to promote the interests of a politically important Democratic constituency at the expense of a group of bondholders he is confident he can portray to the public as unsympathetic.

Megan McArdle said it quite well:

For the record, I have no problem with whatever cramdown those debtholders--or any others--get in bankruptcy court.  If the judge thinks that the reorganization can't be done without making the UAW basically whole, fine.  I just think that the reorganization should be done under the well-established procedures of the bankruptcy court, not at the behest of an administration trying to reward its supporters.

It's all very well to say that most of the senior lenders are going along, but of course, the leading senior lenders are doing this because the administration has them over a barrel.  I think most of the people enthusing about this actually recognize that in other countries, when the government uses the banking system as a slush fund to reward its constituencies, this generally turns out badly--and makes the banking system a lot more frail.

Nor will it fly to claim that the administration's threats--and note that Perella Weinberg has most carefully not denied that they were threatened--are just standard jawboning.  Standard jawboning does not involve the White House bloody press corps.  It is true that DIP financiers often get to demand serious concessions from creditors, but those creditors are limited by what those creditors would get out of a recession, and are aimed at either maximizing enterprise value, or maximizing the likelihood that the loan will be repaid.  This deal does neither.

Perhaps it's idealistic of me, but the American bankruptcy system actually works very, very well.  I think we should be very cautious about mucking with it, particularly when there's no reason to.  The administration didn't need to beat up the creditors in order to reorganize the company--or at least, they wouldn't have needed to do so, if they weren't trying to make the creditors take less than they'd get in a liquidation.  Nor did it need to do so to keep the UAW at the table--unlike capital, the UAW isn't going anywhere.  The administration is beating up the creditors because a) it wants to give the UAW a much better deal than they'd get in liquidation and b) they'd like someone else to pay for it.

Update: More of the same coming out (as I predicted here):

Although the focus has so been on allegations that the White House threatened Perella Weinberg, sources familiar with the matter say that other firms felt they were threatened as well. None of the sources would agree to speak except on the condition of anonymity, citing fear of political repercussions.

The sources, who represent creditors to Chrysler, say they were taken aback by the hardball tactics that the Obama administration employed to cajole them into acquiescing to plans to restructure Chrysler. One person described the administration as the most shocking "end justifies the means" group they have ever encountered. Another characterized Obama was "the most dangerous smooth talker on the planet- and I knew Kissinger." Both were voters for Obama in the last election.

One participant in negotiations said that the administration's tactic was to present what one described as a "madman theory of the presidency" in which the President is someone to be feared because he was willing to do anything to get his way. The person said this threat was taken very seriously by his firm.

The White House has denied the allegation that it threatened Perella Weinberg.

So what may be the most important Chapter 11 proceeding in modern history has begun -- important not just because it is large, but because the court in a sense is being asked to validate or invalidate the unprecedented power grab by the Obama administration.  The results of this trial may well slow or accelerate America's devolution into a European-style corporate state where political pull rather than costs or products determine corporate success.  It also will have a lot to say as to whether the rule of law has any meaning any more, at least as far as President's go.

The first salvo, by the non-TARP secured creditors that Obama was unsuccessful in beating down, has been fired:

Just hitting the Chrysler bankruptcy docket is an objection filed by W&C on behalf of its clients, objecting to the 363 asset sale. The filing is attached below (and linked here). Some very harsh language with regards to Uncle Sam in there...

The summary of the grounds for the objection:

1. The Proposed Sale Constitutes an Illegal Sub Rosa Plan that Redistributes Value Among Creditor Classes.

2. The Proposed Sale Fails the Requirement of Section 363(f).

3. The Sale Is Not Proposed In Good Faith.

4. The Taking of Collateral through a Direct or Indirect Use of TARP Authority is Unconstitutional. (This one is Huge as it sets a case law precedent.)

Over the weekend, there was a lot of back and forth with W&C (White & Case) senior attorney Tom Lauria, who said that one of his clients gave in to the restructuring when threatened by the Obama administration with having its reputation destroyed by the White House press office.   Both the White House press office and the client in question denied this account of events, but never-the-less Obama was indeed vilifying the holdouts, though in a general rather than specific way.

This is probably only the tip of the iceberg.  I think if creditors start to see that the bankruptcy judge is unwilling to automatically roll over for the administration, more such revelations will emerge.  The blog Finem Respice has a doozy, though it is unsourced and so must be treated with caution.

Apparently a number of the lenders to Chrysler were recipients of TARP money, and thus were especially susceptible to Obama Administration blackmail to take less money for their Chrysler debt than they would normally get in bankruptcy court.   In effect, Obama is asking for partial payment for the TARP money in the form of concessions to Chrysler's other parties in the bankruptcy, mainly their unions.

But the TARP money is MY money.  And I don't want to get paid back this way.  If these lenders have the ability now to pay out billions of dollars (in the form of forgiven loans) then I would rather see them returning this money to the Treasury rather than sticking it in the pocket of the UAW or propping up a zombie auto company that hasn't made a car I would even consider buying in over 10 years.

TARP is going to turn out to be the greatest tool ever invented for increasing the power of government in the economy and accelerating the development of the American corporate state.  And Obama can laugh all the way to the bank(s) knowing that it was a Republican administration that handed him this power.

Postscript: I thought this was funny, via Instapundit:

And though I'm not a gearhead, I'm a little surprised to hear the administration saying that Chrysler is going to be saved by"“Fiat's world-class engineering.

All the more so given that Daimler couldn't help.

Good for Megan McArdle:

when 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.

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.

I am not sure I agree with the last part.  While banks seem to have an unbelievably long memory when it comes to you or I trying to get a loan after we forgot to return those Columbia House records 15 years ago and couldn't pay our bills, major banks have goldfish memories when it comes to major losses.  Whether it be lending to Latin American companies or to industries like airlines that go bankrupt with clockwork regularity, banks seem perfectly capable of repeating the same mistakes over and over again.

This is in part due to something I was trying to tell folks waaaaay back in October with the threatened liquidity crisis -- banks have to lend.  There is simply no good business model for a bank that involves sitting on hoards of cash under the mattress.  And when you have tens of billions of dollars to lend, you can't just do it in $100 increments -- you have to lend big slabs to large institutions.  And given that lots of other banks are trying to lend to the same guys, someone is going to issue that $300 million line of credit to Chrysler a couple of years hence.

I am not shocked that Obama is full of sh*t --  all politicians are.  But I am constantly surprised at just how awful the press has become.

Here was the Arizona Republic towing the government line, attempting to stampede the country into subsidizing the auto companies because bankruptcy would be a disaster:

Advocates for the nation's automakers are warning that the collapse of the Big Three - or even just General Motors - could set off a catastrophic chain reaction in the economy, eliminating up to 3 million jobs and depriving governments of more than $150 billion in tax revenue.

Industry supporters are offering such grim predictions as Congress weighs whether to bail out the nation's largest automakers, which are struggling to survive the steepest economic slide in decades.

Even if just GM collapsed, the failure could bring down the other two companies - and even the U.S. operations of foreign automakers - as parts suppliers run out of money and shut down....

Automakers say bankruptcy protection is not an option because people would be reluctant to make long-term car and truck purchases from companies that might not last the life of their vehicles.

There was absolutely no background on the chapter 11 process, or any mention by this reporter or in any subsequent AZ Republic article that bankrupcy meant anything but liquidation and disaster. Not even a hint that many large companies, including the largest company based in Phoenix -- US Airways -- have operated seamlessly through chapter 11.

It was left to bloggers like myself to remind folks that the businesses and assets don't just go *poof* in a bankruptcy, and in fact it is generally in creditors' interests to have the company continue to operate.

So, now that Chrysler is heading for bankruptcy, Obama's incentives are now to make chapter 11 look friendly instead of menacing.  And the AZ Republic is finally, after 6 months of coverage, explaining what this really means:

Bankruptcy doesn't mean the nation's No. 3 automaker will shut down. A Chapter 11 bankruptcy filing would allow a judge to decide how much the company's creditors would get while the company continues to operate. The goal is for the whole process to happen quickly, Obama said, perhaps within a couple months.

I thought this was priceless:

[Obama] said a group of investment firms and hedge funds were holding out for the prospect of an unjustified taxpayer bailout.

"I don't stand with them," Obama said at the White House event.

I actually don't think this is true -- as secured creditors, they are FIRST in line in a bankruptcy.  Obama has effectively told them to voluntarily move to the back of the line, and they reasonably said "no way."  Obama is miffed that they have not taken his royal direction, but I think they are correct they will get more out of a process run by bankruptcy law rather than one run by political pull.

But, even if hedge funds had this expectation of a taxpayer bailout, who in the hell do you think has given them reason to have this expectation?  Can anyone say "moral hazard?"