When I became a corporate bond manager in 2001, one of the first things I began to do was sell away all of my automaker bonds. A big bet I knew, even though I was a neophyte, but I thought it was the right thing to do. I reduced my exposure from $100 million to $10 million. ( I could not get a decent bid for bonds from Ford’s Dutch subsidiary.) My view was that their fixed cost structures were too high, and they would lose to lower cost automakers.
In writing for RealMoney, I always took the tack of selling the automakers’ stocks. I made an exception for their securitized auto loan receiveables, which had me on the other side of Cramer. I always try to draw distinctions for what constitutes reasonable investments with respect to equities or debt; the question is not always the same. But with the automakers, the distinction was somewhat moot, so I encouraged readers to sell all unsecured debts of the automakers maturing in less than three years.
Now, we are nearing the endgame, where GM and Chrysler stocks go to zero, and Ford may as well, as it comes under knock-on stress.
But is it Legal?
I am dismayed at the enthusiasm that many display for giving the US Treasury draconian powers, allowing them to effectively destroy contract law. I don’t care if the Treasury saves the economy or not, what will our society be like when it is done? I have already laid out a simpler proposal where change is incremental, Add a New Chapter to the Bankruptcy Code, which leaves most of the powers in the hands of the courts.
We don’t need to get it done quickly, if the government added a “too big to fail” section to the bankruptcy code. Obligations would be honored, and the courts could sort through an equitable division of the property, or cram it down, if agreement is not rapidly reached.
Even if Congress passes a law allowing the Treasury Department to have incredible discretion in reorganizing financial companies, that does not mean that the actions are exempt from judicial review. The Supreme Court could rule that the infringement on the rights of bondholders constitute an illegal “taking.” I’m no lawyer, so I write this with some trepidation.
My main point is that the US government does not have the power to eliminate the basics of contract law, without making the government itself lose legitimacy. Contract law is basic to all civilized societies, and is a major component of the wealth, which relies on stability.
Beyond that, any plan that creates a good company / bad company should be doomed, because it essentially becomes government sponsored fraudulent conveyance, where valuable assets that the bondholders were relying on disappear.
Don’t get me wrong, I think the bondholders should take a sizable hit here. I just believe that the result should come through the courts, not through the US Treasury. The courts do well at this sort of thing.
It is dangerous to tamper with contract law in such ways. Bond financing for other entities that are anywhere near the bankruptcy cliff will dry up, pushing other firms into insolvency. The Treasury could well save some firms through these powers, should they get them, but at a cost of destroying many others.
The rush should not be this big. Let the government temporarily be a DIP-lender to “too big to fail” firms, but then let the court handle it. They were designed for questions of equity, and they have worked well at that for several centuries. Discretion on the part of bureaucrats at the Treasury will be far less competent (as we have seen so far) and far less fair (ditto).