7thriv

Plenty of negative commentary about the Chrysler rescue plan and its negative effects on Chrysler's bond holders. This is probably the best and pithiest: The Day The Capital Structure Died

Since a debtholder can force a bankruptcy filing when there is a missed payment or other breach it is extremely unlikely that the firm will get 80 billion underwater before someone notices and nails them with an involuntary bankruptcy filing.

As a direct consequence of this senior debt is considered extraordinarily safe and due to that it is very cheap in terms of interest payments over the reference rate (e.g. 10y swaps if it's a 10 year non-callable bond, etc)

Well, now it isn't so safe any more! In fact there may be no differentiation between debt classes at all, and if the Treasury gets involved, you may find yourself staring at a 90% loss with absolutely nothing you can do about it.

The question is no longer hypothetical as it was when I first wrote about it when these bailouts started: If you hold debt in any firm that has received taxpayer assistance, thinking you're safe, exactly how well did you sleep last night? How well will you sleep tonight?

I know the average person might not understand why the problems of a few bondholders amounts to a hill of beans. Certainly, if you are a guy on the Jeep assemblyline, or a Chrysler retiree in Florida, or a Rust Belt congressman, or an economics professor writing for "The American Prospect," or the president of the United States, it might seem strange that your plans would be objected to by a loose coalition of funds and investors waving pieces of paper and yelling "bankruptcy this" and "sanctity of contract that." It almost seems quaint; like watching your grandmother clip coupons.

To the proponents of the Chrysler deal, a huge company like Chryler is the sum total of it factories, its offices, its engineering know-how, its trademarks, its pension plan, its union rules, etc. This is the part that looks solid and permanent and has been held to be worth saving . But, this is only a part of Chrysler. The lifeblood and animating force of Chysler aren't the factories humming with activity, it's the money that comes in either when Chysler's vehicles are sold on the open market, or when Chrysler borrows funds through, among other things, the sale of its corporate bonds. Without that flow of cash, all of Chrysler's parts cannot move. In fact, they are not moving now; its factories have been idled for weeks. The husk is still with us, but the blood is not flowing.

The bondholders - really, you should call them lenders - are crucial to keeping the blood flowing. Without them, all of those employees, retirees, executives, and bureaucrats have nowhere to go. That's why bondholders can make the seemingly unreasonable demands that they do. They were induced to lend Chrysler money based, in part, on the promise that the money would be repaid. Bonds aren't supposed to be a risky investment like stocks. They are supposed to be safe - not risk-free, but safe - and a crucial part of that safety is the right to declare a default and force the debtor into a BK.

Hard as this might seem to accept (and a lot of people don't), a huge industrial concern like Chrysler is not a WPA project or a means to redistribute pension and health benefits. It is a business, and Chrysler's business is the manufacture and sale of motor vehicles. Shortcircuiting decades old BK and contract law in order to "save" a company that can't save itself is an essentially irrational act; a play to artificially preserve labor-management relationships that have been dysfinctional for decades. That the car czar would follow this path shows how little regard he, and his party, have for the most basic elements of the free market.

When workers go on strike, it makes for lots of noise and good TV visuals. When capital goes on strike, it is invisible, but it is more deadly than any picket line. Hopefully, we will not see this return as it did in September '08.