as protection against political risk following the government's pressures on senior and secured creditors of Chrysler?
In my development finance work in the developing world, I have undertaken a lot of negotiations with businesses (mostly media companies) in places ranging from South Africa to Guatemala to Serbia looking to borrow money. The nonprofit private equity fund I work with has standard loan documents, of course, and over the years has looked to tailor them to fit risky investment in these environments with less than perfect adherence to the rule of (contract) law.
As I watch the Detroit restructurings unfold, particularly the strong-arming of senior and secured creditors, I wonder what new covenants creditors might want to put into new bond issuances by US businesses that might eventually become entangled with government. I've been reflecting on this looking back over the standard documents that I have used over the past twenty years. Interestingly, the contract forms I've used do not have very many special political risk terms.
Why not? Because the general assumption is that no political risk covenant can really protect you in a place where contracts are not enforced — political risk of that kind involves yanking the floor out from under the investor altogether. If a contract term that provides for secured creditor status will not be enforced, why think that a covenant requiring repayment in case of political risk such as expropriation will be enforced either? The nature of political risk is that it is a risk running to the very rules of the game.
Of course that is not completely true. There are political risks and there are political risks, if you are investing in the developing world or, alas, today the United States. The United States seems, in these contract matters, not to resemble the rule of law in Angola, sure — but it is distinctly starting to resemble, ever so little-bit-by-little-bit, the rule of law in China. There is a certain amount of neutral contract enforcement, but also a hefty amount of political thumb on the scale, and many uncertainties attached — and without getting hysterical about it, the American trend line is going that direction. It might be most useful to look at Western contracts with Chinese companies to get good ideas on "mixed" cases of this 'sort-of-rule-of-law, sort-of-not', because that seems to be the drift of Obama administration industrial policy.
So here's my question. What covenants would you put into a new bond issuance by an American company — say a non-Detroit car manufacturer — or an insurance company or a health care provide? Some company in which you thought the chances of US government behavior of the kind on display in Chrysler were not negligible or hypothetical over the next decade. Assume you are looking for senior creditor status; not so worried about special issues of secured versus senior status - focus on political risks common to all senior creditors in this new (third) world.
Plenty of commentators have said that creditors will, over time, demand higher interest rates to compensate them for higher risk from political re-ordering of creditor priority. True. Less discussed (as far as I know but I welcome links to good discussions) is that creditors and borrowers will presumably also look to reduce that interest rate hike by trying to reduce the uncertainties of political risk, through bond covenants that would allocate the risks today of future political contingencies. If you can't trust the rule of contract law at all, then those efforts are for naught. But if what happens if you think you can't trust creditor priority in bankruptcy — but other kinds of contract terms might be enforced? Should you negotiate for those covenants, or is this like being a little bit pregnant?
Here's an example. Something I have sometimes negotiated into developing world debt covenants is a political risk form of a poison put. It is merely a standard poison put, used to address changes of corporate control, adapted to political risk. Nothing special. It simply says that if certain political contingencies occur, such as a government (or union) move to take direct or indirect control of the borrower-corporation, the creditor bondholders can at their option put the bonds back to the corporation and require full repayment of principal, and whatever is negotiated for interest and penalties. It is a response to this particular political risk, not of full-blown rule of law breakdown — but instead of what might be under local law a legal move by the government. It allocates the risk and presumably gives the borrower-corporation some incentive not to seek government involvement.
I haven't inserted it often, and have never even thought about trying to enforce it (Montenegro or Macedonia? Zimbabwe? Indonesia?). Is this kind of political risk poison put worth using in future American corporate bonds? Or is it 'a little bit pregnant' and no matter what you wrote in the poison put, it would be subject to the same political re-writing? After all, though I haven't looked, isn't it likely that Detroit's existing bonds have change of control provisions anyway? Leaving aside its practical effect (or not), what about the effect on the interest rate? Would this be likely to reduce the uncertainties and so reduce the interest rate for risk? Or is it a mostly futile exercise?
Finally, let me ask if there are any other covenants you would think to negotiate into future bond issuances to protect against political risks. (And I have to say, the idea that I would ever be publicly airing such a question about leading US corporations and the bond market, looking to my experiences in the developing world for counsel and advice is, well, shocking.)
(Update: A couple of the comments make the very fair point that the assumption of the post is that the government intervention makes the bondholders worse off. The commenters are correct - that is the post's assumption, and it might well be contested. For purposes of this post, however, let me make that assumption, because what I propose to get at is whether there is a reason to seek covenants in cases where the bonholders will indeed be made worse off and, assuming such covenants could be drafted and enforced, what they might be. I grant that I am assuming that the current Detroit interventions make bondholders worse off than otherwise.)
(Further update — a couple of other quick thoughts. Thanks for these interesting comments. On the question of a party getting third party insurance, eg through a swap or other derivative, it might solve that party's problem, but ultimately, overall, new political risk (using my assumptions above) have been introduced into the system as a whole and risk shifting among parties doesn't make that go away (although it might allocate the risks more efficiently to some extent but, to be honest these days, let's not 'bet' on it (a joke sufficiently obscure but funny to qualify for XKCD status??)).
With reference to the question of what's the problem with government intervention if it makes the company stronger - the question is not whether it makes the company stronger, but the next question of whether it makes the bondholders stronger. It's a little like the classic question of what does 'return' mean in the triad of risk, return, and control: there might indeed be a return to the enterprise, but unfortunately you don't share in it. Here, the restructuring (on my assumptions, granted) might leave the company better off, but does so in a way to leave the UAW better off and the bondholders worse off.
With respect to the suggestion that the bondholders might simply insert covenants allowing the bondholders to bail for any reason any time they like ... it's possible that raising the possibility of political risk that a rational bondholder might want to protect against, if possible, is like simply allowing the bondholder the option bail on whatever grounds it likes. I suppose. But that does not seem like the best way to understand the problem. There seems to be a political risk problem that didn't seem to be there before. Asking whether there are specific ways in which that can be addressed in advance - if it can - is not asking to have a free-exit card. Poison puts have existed for decades with specific rights, but also negotiated limits, attached.
Finally - because I have to go to the gym this summer and improve my chances of living through middle age - I want to raise a question about how best to analyze the point in the comments that the only real protection is to charge a higher interest rate. Why? Because if you can't trust enforcement in the future, you should instead collect up front. Of course, carried to its logical extreme, you would protect against everything by lending the money now and collecting a nanosecond later. The comment was not proposing that, but it was proposing collecting higher interest payments in order to have more money upfront to compensate for future risks. How should we analyze that from a financial instruments perspective? Form of an option, I suppose, in which the other party - the government, say - has the option to alter the payback terms in various ways, and so is the holder, while the lender is the writer who is collecting a premium in the form, not precisely of interest payments as such, but rather the excess interest payment over what would have been charged absent the option held by the government. I suppose that is how you would price the additional interest stream, but I am ready to be corrected. Okay off to the gym - an option, I guess, running in favor of God? Or the other way around?)
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I also think it is appropriate to have the borrowers suggest terms that might protect a lender. This is, after all, a two way street.
IIRC, so far the feds have only dramatically rewritten bond contracts for businesses which accepted loans from the feds. Bond issuers might promise not to accept loans from the government, at least the federal government.
Good point, but I have a feeling that this was an accident of history rather than an Obama administration policy.
The federal government made these loans because it was the politically safe thing to do given the political climate. Bush and Congress didn't want automakers going into bankruptcy during the closing days of the campaign, and nothing could have been done during the lame duck period. The loans were the Bush administration and Congress punting the tough choices to the next administration.
Had bankruptcy loomed for GM for the first time in May of 2009, Obama would have realized what everyone realized all along: that loans were a Band-Aid fix that wasn't going to solve GM's problems. The same argument in favor of nationalizing GM would apply: it's too big to fail. I can't see Obama holding back on nationalization of a company that's too big to fail simply because the federal government hadn't loaned it money before.
Very interesting question, but I think it boils down to that a creditor can't really protect itself from the sort of political risks you're talking about through covenants. Since the government can changes the rules and abrogate provisions in contracts, creditor cannot be sure that those covenants will be enforced when they are most needed. There's also the possibility of adverse political consequences if a creditor even tries to enforce those covenants (federal and state administrative agencies have plenty of ways of pressuring companies including creditors).
Thus, I think about all creditors can do is charge higher interest rates and fees to offset the risk of adverse political action. This would not be something all that different from what creditors have to do now regarding bankruptcy in the US, since creditors cannot prevent companies from filing for Chapter 7 or 11. It will be interesting to see over the next few years empirically if companies in "politically vulnerable" industries are charged higher rates than companies in other sectors.
It is certainly an unspoken and unproven premise of this post that the (senior) bondholders are worse off as a result of this intervention. That is not necessarily the case. Of course, the classical way to make sure is to ask them. Unfortunately, in this case the bondholders appear to have been "strong-armed" into acting against their self interest. So much for one of the classical foundations of capitalism, i.e. the assumption that people, when left with sufficient freedom to make up their own mind, will be able to figure out what is in their best interest.
Yes, but that kind of consideration only comes into play once you can no longer trust the courts to enforce contracts as written. Since the original post contains to suggestion that there is a problem with US courts, I don't think such drastic measures are called for.
2. A special case of (1). Make a virtue out of embarrassment, that is included at least one clause which is conspicuously -designed- to cause embarrassment. Something like "if govt does X, then it must also do Y" where Y can range from the president having to wear a chicken suit for a day, to (more palatably) the president having to publicly read a pre-drafted apology for having renaged on the deal (a real eat-crow apology, make it withstand the apologias that follow).
The nice thing about (2) is that although the government -could- ignore the eat-crow clause as well, there should be no public reason for doing so that is even remotely justified. And if Y provides an economic, logistic, and logical 'easy out' for doing X, the president's opponents will be easily excoriated by his opponents.
[For 'president' here, read almost any permutation of political animal.]
There seem to be a few parallels to what's happening in the US, such as the government "encouraged" conglomeration of the chemical industry into IG Farben or the founding of Auto Union with government money?
Please note that I am in no way suggesting present US government to be like 1930s German government. Just that industry had to deal with huge political uncertainty. How did they deal with it?
Anecdotally I am under the impression that getting a place at the table to influence decisions and get early warning of intentions was one strategy. Having a direct line to people in power to get one's contracts favourably enforced was another. Informal measures rather than possibly useless contract clauses.
That should be expressed more clearly. The president would want to justify doing "X" before and after doing "Y" -- he would make an apologia [defence] for doing "X". The statements for "Y" should be drafted with the aim of undermining any such apologia, or else undermining any defense of the president being anything other than brazenly two-faced.
Oh, and largo, you might want to look into the (in)ability of contracts to compel the performance of third party non-signatories, particularly those who are not controlled by a contracting party.
What really screwed the bondholders is that a majority of the senior debt holders were TARP recipients, leaving only a minority of the senior bondholders to oppose the sham sale of assets to the government chosen "winners".
I'd like to think that largo had already considered that, and that he was proposing adding the government to the contract as a party. Instead of what he proposed, one could of course get the government to agree to switch corporate bonds for treasury bonds in a certain way if and when they choose to intervene. But presumably they'd have to receive some kind of consideration...
This would only work, however, for bond-issuers who could be predicted to have unencumbered assets in a foreign jurisdiction that was relatively immune to U.S. pressure -- likely a very difficult thing to forecast.
But the basic insight seems correct - if a bond buyer can't trust the US legal system to enforce bond contracts as written, won't there be pressure to on bond issuers to exit if possible? If bond buyers begin to extend credit preferentially to companies based in countries more committed to the rule of law, won't US-based multinationals then begin to relocate to friendlier jurisdictions?
Regarding the first and third of these, is that possible? Not only might such a covenant be void for being contrary to public order/policy/whatever, but I'm not even sure whether it is allowed to make the bonds callable depending on something that the company does not control. Would it be allowed to make the bonds immediately callable of oil prices rise above $ 200 per barrel? Or if the Yankees win the World Series? Wouldn't that be unlawful gambling?
Whilst that doesn't deal with healthcare, I would expect that healthcare is more likely to be subject to classical regulatory risk than expropriation risk, so it probably is just a question of interest rates.
Insurance, well, I think with any financial institution I would an absolute right to full repayment prior to any government-backed financing, and probably an adjustment to the change of control definition to include accepting significant additional government backing (ie beyond the status quo at the time of contracting).
In every case backed up by personal guarantees from the directors, just like small business lending.
I disagree with your charazterization. The bondholders are against this particular government intervention, but that is at least in part because they know that the alternative scenario is not "no government intervention" but a different kind of government intentional. The bondholders know just as well as everyone else that GM is "too big to fail" and are acting not to minimalize political action but to maximize their benefit from political action.
Off topic, if you're a CIA agent, as a condition of employment, would/can you arrange it so that $10 million is held by your lawyer and would be signed over to you should you be sued or prosecuted for your services as agent by any govt entity or political subdivision? Make all the necessary assumptions. Thanks.
Indeed. The thought of such compulsion makes by blood run cold. It would be nice of such terms could be somehow attached to the political office, in a way that survived the term of the office bearer? I have no idea of what the law requires or permits in this regard.
I must admit, the thought of this is filling me with inordinate glee!
But legally, what happened? Has the enforcement of contracts really been usurped? Didn't the senior creditors just complain alot and then agree to term modifications? How much have the *legal* maneuverings of Chrysler, GM, and the Obama administration differed from is usual in most Chapter 11 bankruptcies?
If a majority of bondholders didn't legally "agree" to Obama's plan, I would be far more receptive to complaints about the erosion of the "rule of law". But even if the agreement was coerced through political pressure, it's legally still agreement, right? Politically all these dealings concern me, but is it really justified to raise these events as an example of the erosion of the rule of law?
Glee?
The only way to get genuine protection is to put in a dead-man's switch. In other words, whatever clause is put in should not be subject to waiver by the lender. If the lender can waive his rights under the contract, then the lender can be threatened to do so. Rather than giving the lender the option of terminating the loan, I'd propose the following (utterly impractical) terms.
Institutional bondholders seem to be a pretty weak-kneed bunch. They seem to be so uncertain of their position that an innocuous statement by the President is considered a "threat", then they probably should take a bath. If they are so certain of their position, why didn't they force GM or Chrysler into bankruptcy earlier?
Bonds should be callable if a company receives any government aid: loans, subsidies, or benefits.
Cheers,
Wouldn't it make more sense if bonds were callable when something happens that adversely affects their value? All the things summed up here are of benefit to bondholders.
No, not unless you believe the Vito Corleone theory of contracts where you haul someone into a room, and put a gun to his head to negotiate an agreement. Obama is a thug and he has given us a thug government. No one should be surprised at what happened to the bond holders.
See above.
...At least during police interrogation there are no guns in the room when the defendant agrees to plead guilty to a lesser charge.
I thought we agreed not to be hysterical?
This is the fundamental problem. If the government is the one bending the rules, which impartial arbiter do you turn to for enforcement? The only constraints on the government are going to be political. This will continue until the electorate realizes this harms the economy and says "enough."
Until then, arms-length transactions will become more expensive due to the risk of governmental interference. Then again, the market may compensate by developing mechanisms to estimate political risk, just like we have mechanisms to estimate risks from a variety of other causes. Still, the existence of this new and dangerous form of risk will shrink the economy simply by ensuring that many marginally beneficial transactions don't take place. For example, businesses with large union labor obligations are likely to become economic lepers in such a scenario.
The only defenses a creditor has to government nationalization of private firms and the voiding of their contractual obligations is to limit lending to short term bonds at high rates of interest with a higher risk premium for firms saddled with unions that are more likely to demand and receive Dem government intervention.
I was severely depressed reading the appalling Chrysler bankruptcy court opinion approving the government looting of the auto maker's creditors to finance a hybrid union/government nationalization. The judge found as a matter of fact that the government strong armed the entire deal and then justified the looting of the secured creditors based upon a single Chrysler witness claiming that the bond holders would receive more under the government plan than the alternative of breaking up Chrysler. The Court did not allow the bond holders a reasonable time to conduct discovery, nevertheless engage expert witnesses of their own, based purely upon government blackmail that it would yank financing if the Court did not immediately approve the sale of all useful assets to the nationalized New Chrysler.
Welcome to the new American socialism.
This analogy is obviously inapt. I think a better analogy is if I was the holder of a "naked" CDS on Citibank stock. If Citibank had been forced to file for bankruptcy, I would be a big winner! But politics prevented any real chance of Citibank filing for bankruptcy. Are the Obama and Bush Administrations "thugs" for keeping money from falling into my hands? I don't think so. Did their rescue of Citibank violate the rule of law? No, not really. Does it hurt me financially? Yes. Are their actions the basis of sound national economic policy? Not necessarily.
I don't particularly agree with Obama's policies (but I'm no expert in the area of corporate restructuring, either). But that said, it still isn't clear to me that the rule of law has been subverted.
1) Wait for a regime change in the country;
2) Determine if the new leadership is more trustworthy;
3) Don't purchase bonds that mature outside of length of term of the government.
As of today, I have exactly the same suggestions regarding US debt in companies with large union workforces.
You raise an interesting issue. The United States used to act to change regimes in Latin America to defend the rights of American creditors who lent money in those countries. Has the United States now become a banana republic where foreign countries will actually discuss changing our ruling regime to compel deadbeat Americans to honor their debt obligations?
So.....Obama threatened to kill the bondholders?
Of course I was engaging in a bit of dramatic invective to make a point, but your example is even further from the mark. The Obama administration made direct threats (which they deny) if a certain bond holder were to assert his rights under contract. You may choose to believe Obama-- I don't.
It seems to me that bond covenants written to supposedly insure security actually do no such thing, but rather provide cover, and employment for future lawyers.
Ultimately, the problem was the fecklessness (in this instance) of the Bush administration.
Cheers,
Explicit put options on bonds are unusual, probably because of a lack of volatility on most bonds. The same function as what you're proposing is fulfilled, however, by the now much maligned Credit Default Swaps. That's what they are/were for, to insure against default risk.
No company could agree to make their loans callable or have anything bad happen itselfs if itsemployees unionize. To do so, would violate 29 U.S.C. 158(a)(1) and would therefore be void as a matter of public policy.
Thanks for the research, as noted above, I suspected that that would be the rule. Makes sense.
And there is no way the courts could intervene when a bondholder exercises a broad provision like that even if their reasons are contrary to public policy.
As you acknowledge, the assumption of your post is that intervention made the bondholders worse off. That does seem to be a highly speculative assumption.
Is your question even worth asking if that assumption is not true?
Let us assume that they are worse off. I think, if they are worse off, it is only at the margins. That is, instead of getting 21 cents on the dollar in bankruptcy, now they are getting 20 cents on the dollar. In either way, bondholders are pretty unhappy. Right, it is just they are slightly less unhappy if they get 21 cents on the dollar instead of 20 cents. But, I think when they originally invested, they were hoping to have a positive rate of return, not a negative rate of return.
Anyway, overall, I think your post IS hysterical (despite your attempts to make it otherwise) in comparing the United States to developing countries. The problem that bondholders REALLY have is not the United States government reducing their rate of return slightly. Their problem is that they decided to invest in GM, which failed as a company. Presumably, at least as of right now, they would have been much better off to investing in Ford or Toyota.
Basically, the losses that bondholders have felt are PRIMARILY because they have invested in a company that failed. THAT is always a risk that one faces when one decides to invest in corporate bonds. The issue of whether the government made those losses slightly worse or slightly better (and I do think it IS speculative to assert that the government made them slightly worse) is a side issue.
Contrast this to situations where government intervention does not merely have incidental effects on the rate of return but is of primary importance. For example, when the state expropriates an entire business that was SUCCESSFUL, wiping out both stockholders and bondholders.
However, your question, although it is certainly a side issue in terms of importance, it is definitely one that would tend to especially interest libertarians, who have an ideological interest in dramatizing the supposed negative effects of government intervention.
Like the Indiana Police and Teachers pension funds. But that is beside the point. The point is that favoring unions and other 'good guys' over the 'bad guys' is going to mean only the 'bad guys' are going to get access to capital and prosper in the long term. The Obama administration is dooming its favored interests to long term failure by its short term abrogation of property rights.
I would not want to be the one to defend that when the NLRB comes calling. The problem is that if you were to let it be known that this was the plan, that would in of itself violate 29 U.S.C. 158(a)(1). The bottom line: imposing any negative consequences on employees based on whether or not they unionize is illegal under the NLRA.
P.S.: the entity that would stop you is not a court, but rather the NLRB (I worked for them while I was in law school and they do not tolerate sham transactions to frustrate the the NLRA).
Without condoning the behaviour of federal prosecutors, there is a fundamental difference between the two situations. The criminal system is set up with the government being on one side of the dispute. This asymmetry is built into the system, and is understood from the start. Even then, if the prosecutor said "go for the plea bargain or the we'll have the president pronounce you guilty live on the 8 o'clock news" there would be considerable outrage. Yes, I think that prosecutors should try getting the best outcomes, not getting the most convictions, but in any case they are supposed to have opposite interests to defendants.
The civil law system is set up where disputants generally are on the same footing [sovereign immunity is a blot on this, but is not an issue with our discussion]. If GM would like to reorganize but the bondholders might prefer liquidation, this would normally be resolved in bankruptcy court. Instead, Don Obama has obtained a controlling interest in GM, and is now using tactics that were not available GM's previous management. This is simply not the same as a criminal plea bargain discussion.
The bondholders now find the government as stockholder, but that as such doesn't change the bondholders' legal position. I'm not aware of any attempt by the government to use its power as government to change the outcome. (For example by passing a law in Congress mandating this reorganisation.
Hence my comparison with the plea bargaining process: In both cases, it is a more or less "free" bargain, albeit one made under considerable pressure.
Presumably, however keen the NLRB might be, they have to convince a court to go along with them at some stage. Would a US court be likely to construe entry into a contract with such a clause as offending 29 U.S.C. 158(a)(1)?
In fact, the "strong-arming" amounts to the federal government saying "I am willing to make large loans to GM but only given these concessions. Take it or leave it." If a private investor did the same thing, he'd be lauded as a hard-nosed businessman. At any rate, the union-busting comments show what this is really about.
Now, you might say that private parties commonly use the press to put pressure on each other during negotiation. More to the point, prosecutors commonly call press conferences in which they name suspects and express their belief in the guilt of these suspects, ruining people's lives independently of the result of the court case, if it takes place at all.
The point where we depart is that I think the word of the President of the United States still carries a weight not shared by the average prosecutor or corporate spokesperson. Thus I judge differently a threat by the President to tar your name from a threat by a prosecutor. Both are evil, but prosecutors have been calling so many press conferences that I think everyone realizes then for the bargaining trick that they are.
Perhaps I give the US government too much credence (for example, it didn't occur to me that Colin Powell would lie to a UN panel), but I think there'd be a big difference between the press coverage and public reaction accorded to a press release from GM saying "these recalcitrant bondholders are harming our workers and shareholders" and a new conference featuring POTUS saying "these recalcitrant bondholders are harming the people of the US".
What's more, when we're talking about political risk/country risk, this is only a conversation worth having if the investors cannot rely on the courts to enforce contracts. Since there is no evidence that US courts don't do that, the only way to get from Chrysler to a conversation about political risk is to claim that the government "strong-armed" these investors into forgoing their legal rights, including their right to sue Chrysler in a court of law in case of default.
As long as there is no evidence that Obama forced anyone away from the courts, there is simply no coversation to be had about political risk.
You have got to be kidding me. The entire world financial sector has swallowed whole and spit out (not to mention spit at) for almost two years now. You can't convince me that they would tremble in their boots at the prospect of being called meanies by the president.
As for those major bondholders who are not financial institutions, like that Indiana Pension fund, I don't see how they would be particularly concerned either. If the President is going to stand up and decry the bondholders, they are hardly going to take the brunt of the blame.
No, what happened here, according to the WSJ article prof. Anderson just linked, is that the bondholders were given a choice between a mess of a bankruptcy, or a reorganisation at the government's terms. Take it or leave it. The bondholders simply chose the best deal that was out there.
Now, one can argue that there was an unconscionable bargain here. I would certainly agree that the bar for unconscionability should be lower if we're talking about the government. That is why we don't allow people to barter away their constitutional rights when they're negotiating with the government. But in this case there's no way these bondholders were disadvantaged enough to make the bargain unconscionable, neither legally nor morally.
In a free country like America, there is no guarantee that when your investment decisions will not be subject to criticism. Deal with it.
I don't think so. Your point about Constitutional rights could be accommodated without a different standard for the government. In fact, I think there are a lot of situations where the government is less likely to try to screw you over than a private actor. For example, in student loans, I would have a tendency to trust Direct Loans more than private loan loan companies.
Secondly, the government is a creature of law, created by the people to serve the common good. As such, we are in certain circumstances entitled to expect it to refrain from immoral behavior, even when such behavior would be immoral but not unlawful if another citizen did it.
Viewing this case through the lense of unconscionability, I think there is no question that this would be entirely OK if the reorganisation had been carried out by a wealthy hedge fund. (If there are any left.) Given that, instead, it is the government bailing out the auto industry, the argument that it behaved unethically to the point of being unconscionable is somewhat more credible. (Though I still don't believe it.)
I agree that "power" is an important factor, but, I don't think I buy this generalization. This is a context specific thing. A small school district might have less bargaining power in buying books than a large retail chain like Costco. To throw an example out there.
Corporations are also creatures of law, and we also expect them to serve the common good. That is why we offer the owners of corporations limited liability. Of course, some argue that the common good is maximization of profit. Anyway, that debate is for another day. But, corporations, like governments, are also creatures of law. The purpose that the law has in mind in chartering corporations is to advance the common good.
To the extent that you think this case is any different, I disagree with you completely. If it is okay for a hedge fund to withhold its funds from GM in order to get a better deal vis-a-vis bondholders in order to maximize profit, I think it is okay for the government to do the exact same thing in order to minimize the extent that taxpayers are subsidizing bondholders (who probably would lose even more money absent government intervention).
Basically, it sounds like your argument is that the government sometimes has a moral obligation to subsidize those it does business with, even if those parties are extremely sophisticated, instead of cutting the best deal it can. As a taxpayer, I object.
There are situations though, especially when it is negotiating with a counterparty who is not sophisticated or a business, when I think the government should be under particular scrutiny as far as unconscionability is concerned. (Quod licet Iovi non licet bovi.)
I can't think of a good example right this moment, but if you'll settle for a slightly less appropriate example, I'd offer plea bargaining. I have grave concerns about the way US prosecutors leverage a possible more serious charge in order to get a guilty plea on the "lesser charge". (Earlier I linked to this recent Volokh thread, where the defendant plead guilty to a crime instead of contesting the constitutionality of the charge, for fear of being charged with a stack of federal felonies.)
I of course agree that there are situations where we should be concerned about the negotiating power any powerful party, including government, brings to bear when negotiating with a much less sophisticated party. I am just going to argue against any generalized prejudice where you are more concerned about powerful government actors versus powerful private actors.
Of course, it should be pointed out that the powers that units of government legally exert is different than private parties in similar contexts. A government actor might be more constrained or more enabled. (I.e. a government negotiating where both parties know that eminent domain is a distinct possibility if a deal is not reached.)
Basically, I think we are in agreement here. Let us just say I am against generalizations in this area either ones that say we should always be more concerned or less concerned about government actors. I get the sense that this is basically your position. You think there are specific situations where we might be more concerned about a government actor, because it brings unique powers to the table in that context. I couldn't agree more.
"Mr. President, it is not only possible, it is essential. That is the whole idea of this machine, you know. Deterrence is the art of producing in the mind of the enemy... the FEAR to attack. And so, because of the automated and irrevocable decision-making process which rules out human meddling, the Doomsday machine is terrifying and simple to understand... and completely credible and convincing. " from Dr. Strangelove
given that the situation here wasn't outright seizure but strong-arming it's all about Schelling's power of constraint. the important thing is that the contract not just involve the creditor and the debtor but a third party because if the government can help abrogate debt so could it any other bilateral contingencies (including the thing about the chicken suit). so if "A" is a debtor and "B" is a creditor, it's pointless for "B" to demand that "A" double pinkie promise to honor its debt but helpful for "B" to make a public and legally enforceable promise to pay "C" some punitively large amount if "B" were ever to "voluntarily" accept an unreasonable haircut on the debt.
let's make it concrete, imagine if the Indiana Pension Fund had written a contract to some third party, say, Chase bank, promising to pay Chase a billion dollars if Indiana were ever to accept below 50 cents on the dollar on its Chrysler bonds outside of a bankruptcy court. if the government were to try to strong-arm Indiana into accepting 30 cents Indiana would have to refuse because it would be terrified of Chase enforcing its punitive contract. the government would then be in a position of having to strong-arm both Indiana to relax its debt on Chrysler and Chase to relinquish its claim on Indiana. this is certainly plausible but i think Indiana is safer by putting itself between a rock and a hard place than just putting it against a rock.
What would Chase's consideration be?
i'm not sure i understand the question. in my scenario the upshot for the third party ("Chase") would be that they get to demand a lot of money from the creditor if the creditor is too forgiving of the debtor. it's entirely possible that the third party could fail to press these rights (probably because it too is being strong-armed) but my point is that such an arrangement at the very least makes it more inconvenient for a politically connected debtor to abrogate as it effectively now has a first-order and second-order creditor and you need to squeeze both of them.
if your question is what does Chase have to put into the deal to gain such leverage over the creditor, my answer would be a single dollar plus its reputation as being sufficiently ruthless as to try to enforce such a contract.
Hey - there is fun on the whole slithering descent into half baked socialism. This isn't Fabian Socialism its Surfboarder Socialism.
The whole thing is a typical socialist joke – the kind you used to hear in the Soviet Union and now hear in the US.
The "Cuban Situation" is the story of a Cuban family who was chased out Cuba and whose assets were taken away by the Jefe and his government - The local strongman says: "Screw you Ricardo! The workers are important and you are a blood sucker. Then they give the plant to the one party workers’ collective."
Ricardo and his family escape to the US and save and work hard and invest in GM bonds in their new free safe country. Then the new Jefe comes in and tells them: "Screw you Ricardo! The workers are important and you are a blood sucker. Then they give the plant to the one party workers’ collective."
In point of fact, I think it is highly unlikely that the U.S. government would have intervened in secured creditor rights or imposed any serious pressure on Chrysler's internal affairs if Chrysler had not turned to the U.S. government as a lender of last resort. If they secured control of the company's board through conversion or warrants or similar financial distress triggered right, they could have refused to borrow from the U.S. as a matter of last resort, or could have better dictated the terms of such a loan.
If so, this is yet another example where the creators of novel securities ignored the crucial problems of moral hazard created by the process of hedging risk with securities.
OTOH, evidence has already appeared that the federal government threatened to use the FDIC's discretion to close down banks against skeptical banks if they refused to accept TARP money and its conditions, so we can't rule out the possibility, though at this point entirely speculative, that the bondholders were coerced here too. The TARP coercion went far beyond unconscionable but still voluntary negotiations -- it involved actual threats of the coercive and discriminatory use of regulatory discretion.
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