Prior to the invasion of Iraq, Secretary of State Colin Powell supposedly told President Bush: “If you break it, you bought it.” His point was that, if U.S. actions in Iraq caused the Iraqi state to fall into chaos, the U.S. would assume a special long-term responsibility to pay for its actions by ensuring that the Iraq was returned to a state of stability.
I wonder if the same could not be said for what the current Administration is doing with Chrysler and the securities and debt markets. The Administration has inserted itself into the bankruptcy process to an unprecedented degree, browbeating creditors to accept much less than they would be entitled to receive otherwise. That activist approach may have short-term political gains, by advancing the interests of the United Auto Workers and its members who are Chrysler employees, but it also may have a significant long-term negative impact on how our economy operates.
Capitalism works only if investors are willing to assume risk. The priority rule helps to quantify what the risk really is. Under that rule, there is a pecking order that establishes where people line up in the event of a corporate failure. Secured creditors and unsecured creditors, for example, both have priority over simple stockholders.
By injecting politics into the equation, the Administration is changing the risk analysis. Such changes, in turn, inevitably will affect the willingness of investors to assume risk. If investors have no assurance about where their investments will fall on the priority list, they will be less likely to assume the risk of their investment — or will require a higher interest rate to compensate for the risk that the President or Congress will try to intimidate them into accepting less in a bankruptcy than they would have received if the priority rules were inviolate.
We may not care about Chrysler — it builds crappy cars, which is part of the reason why it has failed — but we should all care about continuing to have an economic system where people can make reasoned judgments about investment risk and whether they should assume that risk. Some years ago I worked on a case involving “high-yield debt,” known colloquially as “junk bonds,” and was fascinated to learn a bit about how that part of our economic markets worked. Essentially, the ability to sell high-yield debt gave some struggling companies a possible mechanism for survival, if they could convince investors that they had a business plan that could turn the company around and, if that plan failed, that they had assets sufficient to allow investors to recoup a reasonable portion of their investment in a bankruptcy proceeding. The individuals who managed the high-yield investment funds were impressive, bright, hardworking, savvy individuals who were committed to carefully examining the risks presented by each offering and deciding which companies offering high-yield debt best merited an investment. Many of the companies offering such debt in fact succeeded with their business plans and were able to retire their high-yield debt, return to profitability, and survive to this day. Those companies employ thousands of workers — workers who would not be employed if the high-yield debt offerings were not available. If there had been no certainty in the bankruptcy priority equation, however, those bonds may never have been marketed at all, or perhaps only at crushingly high interest rates that would have made it much more difficult for the issuer companies to pay the interest and principal and survive.
What does this mean? Only that the pieces of our economy are interrelated and are dependent on individual willingness to shoulder economic risk. In its zeal to have Chrysler survive in a fashion that benefits the UAW, the Administration may have undercut investor ability to assess risk, and thereby harmed its ability to count on private investment to help ensure the survival of GM, or struggling banks, or other businesses that are traveling a rocky road in these tough economic times. The potential consequences of such a result are profound indeed.
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