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Banking on Bankruptcy--Skeel

This op-ed by equity fund manager Scott Sperling in today’s Wall Street Journal makes an interesting case that the Obama administration’s handling of Chrysler and GM is actually evidence of capitalism at work. In my view, he’s right that the restructuring of these companies has some similarities to how things would play out if the government weren’t cramming down its own preferred plans. Both companies would have filed for Chapter 11, and would have been restructured. But the op-ed strikes me as very misleading in its suggestion that restructuring of Chrysler in particular can be squared with the bankruptcy laws. In talking about Chrysler, Sperling seems to suggest that it’s fine to give employees, retirees or anyone else (including current stockholders, presumably) a large stake in the new company, so long as they aren’t allowed to keep everything they have now. That is, he seems to forget the rules of priority, which say that the senior lenders are required to be paid first. When he turns to General Motors, on the other hand, he suddenly remembers the priority rules. The recalcitrant bondholders really aren’t entitled to anything (or much of anything), he argues, because the government, as senior lender, is entitled to be paid first.

In my view, he’s right about GM and wrong about Chrysler. The government’s commandeering of the Chrysler bankruptcy, and rewriting of the priority rules, has laid the groundwork for a lot of mischief in the future.
 
Also on the bankruptcy front, Cleary Gottlieb lawyer extraordinaire Lee Buchheit and I have a little op-ed today arguing for a new approach to the financial distress of large, systemically important financial institutions. We propose that lawmakers provide for a 60-90 day interim period as a prerequisite to bankruptcy proceedings. In my view, the existing bankruptcy framework, this proposal, or the enactment of special bankruptcy provisions aimed at large nonblank financial institutions are each preferable to the current administration proposal, which would dramatically expand the FDIC’s authority and would continue the strategy of relying on bailouts. I hope to outline these thoughts in more detail in future posts and commentary.
 

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Comments ( 2 )

David,

(Full disclosure, I am former student of yours at UPenn law)

I want to offer a slightly different perspective on your post here and your articles elsewhere on the backroom dealing the Obama administration engaged in (my characterization) to favor the unions over more senior creditors.

If we only look at the auto bankruptcies alone, in a vacuum, I agree there is something seriously wrong with throwing out the priority rules that form the basis of corporate lending. However, we do not live in a vacuum. Many (though not all) of Chrysler and GM's bondholders I would venture to guess are bond and pension funds that hold many other bonds, including Fannie Mae, Freddie Mac, AIG's, Bear Stearns, Citigroup, and B of A. The Federal Government all but guaranteed these entities outstanding bonds. In other words, those bonds are, for all in tents and purposes, worth 100 cents on the dollar. However, if the Government had let those companies go into bankruptcy, the bondholders would have gotten much less. So by the Government meddling in the private markets, those bondholders benefited greatly.

I understand that this does not take into account vulture funds who bought GM bonds because they believed that they were mispriced vis-a-vis their recovery value in court. But my is guess is that most of the holders are large bond funds that have held these bonds for years and did not buy them recently. If I am wrong about this, then I completely agree with your posts and articles on the issue.

Matt: I definitely think there's a lot to this-- a lot of the creditors involved in Chrysler and GM have themselves been both direct (e.g., through TARP money) and indirect (e.g., the banks whose bonds have been implicitly protected) beneficiaries of gov't money. But as you note, not all of the creditors fit this description. And the distortions of the bankruptcy rules that have resulted could cause real problems down the road. The Chrysler ruling already seems to be causing mischief (e.g., it's been invoked in the Phoenix Coyotes bankruptcy) and I suspect there's a lot more to come.