The focus of The Rational Walk has always been on business and investment topics rather than political commentary, but lately is has become increasingly clear that the line between politics and business has ceased to exist when it comes to the toxic interplay between the auto bankruptcies and the interests of the Federal Government in the nation’s banking system. Far from being an isolated intrusion by government into the private sector, recent actions run the risk of permanently impairing the nature of our capitalist system.
The presence of the Federal Government in the banking system permitted officials to exert unprecedented influence on the secured creditors of Chrysler Corporation (many of whom were TARP funded institutions) and essentially forced these creditors into the position of junior creditors behind the United Autoworkers and the government itself. Creditors have fared nearly as poorly in the General Motors bankruptcy. Throughout this process, government officials have portrayed creditors as wealthy speculators who are standing in the way of “saving” a vital American industry. President Obama famously stated that he “does not stand with the speculators” when it comes to restructuring the auto industry.
Perhaps the administration can be forgiven for not understanding the nature of corporate capital structures given the near total lack of private sector experience among high ranking officials. Secured bondholders stand first in line to claim assets in a normal bankruptcy proceeding, followed by unsecured creditors, preferred stockholders, and finally the common stockholders. This pecking order forms the very foundation of capitalism and the well established and understood nature of various types of securities.
The abrogation of the clear rights of secured creditors will have long lasting impacts on American capitalism for years to come. If the treatment to be expected by a senior creditor is no better than an unsecured creditor or a union can expect, the cost of capital will increase particularly for politically sensitive industries with powerful constituencies. Capital in general will become more scarce and more expensive as risk premiums have to price in political risk as well as the usual business risks that are part of the practice of security analysis. Higher costs of capital will mean that fewer business ventures are initiated, fewer jobs will be created, and chronically depressed communities will take longer to achieve some semblance of prosperity.
Today, most economists look back at the Smoot-Hawley Tariff Act of 1930 as one of the blunders that sent the United States economy into a decade-long depression. Future historians may well look back at the events of the spring of 2009 and conclude that the Federal Government’s treatment of the creditors of General Motors and Chrysler further deepened the economic downturn we are currently experiencing.
At times like this, it is perhaps instructive to view the consequences of this type of capricious government behavior on an individual General Motors bondholder. While this individual is clearly not a sophisticated investor based on her comments and certainly should have diversified her holdings more intelligently, she had a right to expect that her place in the capital structure of General Motors would be respected in a bankruptcy situation. President Obama and others may wish to observe the reaction of one of the maligned “speculators” they crusaded against in this disgraceful abuse of the capitalist system.
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