Monday, June 13, 2011

Obama & Brown - Bailout Truth or Fiction

On June 3, 2011, Obama and his fair haired boy Sherrod Brown visited Ohio to visit a Chrysler plant in Toledo. It’s clear to me that this is part of Obama's 2012 campaign to make people think that his policies have “created or saved jobs,” and that they are better off than they were in early 2009. Recent polls suggest 59% of Americans are not buying that line. So, what do liberal Democrats do when the facts don’t support their policies? My experience in following the Obama administration tells me that they make comments that are “factually correct, but intended to deceive.” An excellent editorial in the Wall Street Journal on the Monday after the Toledo visit by David Skeel, a law professor at the University of Pennsylvania, confirms my suspicion, saying:

President Obama's visit to a Chrysler plant in Toledo, Ohio, on Friday was the culmination of a campaign to portray the auto bailouts as a brilliant success with no unpleasant side effects. "The industry is back on its feet," the president said, "repaying its debt, gaining ground."

If the government hadn't stepped in and dictated the terms of the restructuring, the story goes, General Motors and Chrysler would have collapsed, and at least a million jobs would have been lost. The bailouts averted disaster, and they did so at remarkably little cost.

The problem with this happy story is that neither of its parts is accurate. Commandeering the bankruptcy process was not, as apologists for the bailouts claim, the only hope for GM and Chrysler. And the long-term costs of the bailouts will be enormous.

Do you think a non-union auto maker would have been saved? No, they would have gone through the normal bankruptcy process where the law would decide who gets paid by the sale of the assets, and the owners (primarily the debtors of the companies) would have enjoyed the profits from the recovery of a leaner, lower cost, less leveraged company. That was not going to happen. Obama and Brown cannot count on distressed investors to fund their election campaigns.

Mr. Obama set up an auto task force headed by "car czar" Steve Rattner. Under the strategy that was chosen, each of the companies was required to file for bankruptcy as a condition of receiving additional funding. Rather than undergo a restructuring under ordinary bankruptcy rules, however, each corporation pretended to "sell" its assets to a new entity that was set up for the purposes of the sale. With Chrysler, the new entity paid $2 billion, which went to Chrysler's senior lenders, giving them a small portion of the $6.9 billion they were owed. (Fiat was given a large stake in the new entity, although it did not contribute any money). But the "sale" also ensured that Chrysler's unionized retirees would receive a big recovery on their $10 billion claim—a $4.6 billion promissory note and 55% of Chrysler's stock—even though they were lower priority creditors.

If other bidders were given a legitimate opportunity to top the $2 billion of government money on offer, this might have been a legitimate transaction. But they weren't. A bid wouldn't count as "qualified" unless it had the same strings as the government bid—a sizable payment to union retirees and full payment of trade debt. If a bidder wanted to offer $2.5 billion for Chrysler's Jeep division, he was out of luck. With General Motors, senior creditors didn't get trampled in the same way. But the "sale," which left the government with 61% of GM's stock, was even more of a sham. If the government wanted to "sell" the companies in bankruptcy, it should have held real auctions and invited anyone to bid. But the government decided that there was no need to let pesky rule-of-law considerations interfere with its plan to help out the unions and other favored creditors.

A more insidious effect of the bailout is less evident:

The indirect costs may be the worst problem here. The car bailouts have sent the message that, if a politically important industry is in trouble, the government may step in, rearrange the existing creditors' normal priorities, and dictate the result it wants. Lenders will be very hesitant to extend credit under these conditions.
This will make it much harder, and much more costly, for a company in a politically sensitive industry to borrow money when it is in trouble. As a result, the government will face even more pressure to step in with a bailout in the future. In effect, the government is crowding out the ordinary credit markets.

The only thing the American taxpayer didn’t have to pay for on this trip was Mr. Obama’s lunch, which I am sure FLOTUS would not approve of given her new definitions of what a healthy diet should look like. Of course there are rules for politicians and the politically connected and then there are rules for the rest of us. In essence, GM and Chrysler got a waiver from reality. As I tell my daughters about boys, “Watch what they do, not what they say.” Obama had the nerve to say to the Chrysler workers; “That core idea of America –- that if you work hard, if you do right, if you’re responsible, that you can lead a better life and most importantly pass on a better life to your kids -- that American Dream felt like it was getting further and further out of reach.” It is interesting to hear this from the modern day Robin Hood.

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