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What New Bond Covenants Would You Demand

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?)

cboldt (mail):
I think you've pretty well identified the scope of the covenants' practical value, to stifle management's decision to approach the government. But if government asserts itself over a company, it may well also find that such covenants can't be enforced as a matter of law. See, e.g., the value of seniority and security in government managed bankruptcy.
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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.
6.2.2009 11:20am
rick.felt:
The only way I'm lending money to any company that might go through a GM-style government takeover is if I'm given Jon Stewart as collateral. He will be kept in my basement, and will be released when the debt is paid or discharged in a normal bankruptcy proceeding.
6.2.2009 11:21am
roy:
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.
6.2.2009 11:22am
Justin (mail):
What were the value of those bonds absent any government involvement? What does that say about the comparison to China?
6.2.2009 11:28am
rick.felt:
Roy:

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.
6.2.2009 11:32am
Calderon:
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.

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.
6.2.2009 11:35am
martinned (mail) (www):

What were the value of those bonds absent any government involvement?

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.
6.2.2009 11:36am
Calderon:
One other thought is that creditors could buy protection in the credit default swap market, assuming it survives.
6.2.2009 11:38am
mls (www):
Isn't the key to enforcing these covenants having a forum (eg, international arbitration) that is not subject to the control of the government in question, and/or the ability to get access to assets that are outside the government's control?
6.2.2009 11:39am
martinned (mail) (www):

Isn't the key to enforcing these covenants having a forum (eg, international arbitration) that is not subject to the control of the government in question, and/or the ability to get access to assets that are outside the government's control?

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.
6.2.2009 11:44am
largo (mail):
1. If possible, arrange terms so that any government shenanigans becomes overt, blatant, an obvious case of favoritism, etc, etc. I don't know how to go about this in any particular way, but it can help to make the government act as politically costly as possible.

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.]
6.2.2009 11:45am
RainerK:
Could it be of value to look at what banks and private industry did in 1930s Germany to cope with the often unpredictable political moves by the omnipotent leaders?
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.
6.2.2009 11:50am
largo (mail):
(a real eat-crow apology, make it withstand the apologias that follow).

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.
6.2.2009 11:52am
Bob White (mail):
Seconding some of the earlier comments, I'd vote for including political risk covenants as being like "a little bit pregnant", though I admit my real international experience is practically nil.

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.
6.2.2009 11:55am
Kazinski:
I think a clause that makes the bonds immediately callable if the firm's workforce unionizes, or take government funds, or a majority of the firms senior debt holders take government funds.

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".
6.2.2009 11:57am
John Stephens (mail):
Don't invest in politically risky industries. End of problem.
6.2.2009 11:58am
Josh Poulson (mail) (www):
Since the government is comfortable with taxing 90% of the bond repayment if it feels like it (as excessive capital gains or some other garbage like that), what point is there in any time spend adjusting the wording of the bond?
6.2.2009 11:59am
martinned (mail) (www):

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.

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...
6.2.2009 12:00pm
Brennan:
I know nothing about bonds, but ... along the lines of MLS's suggestion above: how about a provision allowing the bondholder, in the event of default, to immediately seize any of the bond-issuer's assets held in a non-U.S. jurisdiction. In other words, require the bondholder to avoid a hostile sovereign by contractually agreeing to forum-shopping.

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?
6.2.2009 12:02pm
martinned (mail) (www):

I think a clause that makes the bonds immediately callable if the firm's workforce unionizes, or take government funds, or a majority of the firms senior debt holders take government funds.

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?
6.2.2009 12:02pm
[insert here} delenda est (mail):
Seconding Kazinski that the relevant covenant should be that they will not unionise.

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.
6.2.2009 12:07pm
Justin (mail):
Martinned,

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.
6.2.2009 12:08pm
Houston Lawyer:
As identified above, the real problem is that the government effectively controls a majority of the lenders. If you are a non-government controlled lender, you are screwed, because the government is hostile to your position. The Chrysler and GM bondholder screwing could not happen here without that confluence of events.
6.2.2009 12:08pm
IANAL (mail):
IANAL, but how about deeds and titles to property be held off-shore with stipulation that they all be signed over to the bondholder via power of attorney if the govt ever does "X?"

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.
6.2.2009 12:08pm
martinned (mail) (www):
@Justin: True, but that is just another way of saying that this is the best deal out there for the bondholders. Nothing you're saying implies that they would get a better deal under complete intervention-free bankruptcy. (Nor could it, I suspect.)
6.2.2009 12:16pm
Largo (mail):
Bob White: Oh, and largo, you might want to look into the (in)ability of contracts to compel the performance of third party non-signatories...

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!
6.2.2009 12:17pm
Curt Fischer:
I am confused by the recent events surrounding the trip of Chrysler and GM into bankruptcy. Sure, senior creditors were "forced" into agreements against their supposed interest. It all sounded very shady and political. I wasn't necessarily happy about it...

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?
6.2.2009 12:18pm
Justin (mail):
martinned, I agree. The bondholder's actions can't be seen as evidence for or against whether the bonds would have more value without government intervention. My guess is that the bond value would be incredibly low without government intervention, because GM is not particularly solvent and probably could not pay a substantial portion of their debts without government intervention (including loans).
6.2.2009 12:18pm
martinned (mail) (www):

I must admit, the thought of this is filling me with inordinate glee!

Glee?
6.2.2009 12:23pm
martinned (mail) (www):
@Justin: That would be my guess, too, if for no other reason that a bankruptcy, especially one with no or little takeover as a going concern, would take years to disentangle.
6.2.2009 12:24pm
Lior:
mls: the problem is not with the courts being under control of the government, it's with the government strong-arming bondholders from asserting their rights in court. In fact, if the contract called for international arbitration the political pressure would be even greater.

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.

A. Termination of the loan.

(1) In cases of termination (a) The principal and any accrued interest shall be repaid within [fixed period]; (b) a subsequent loan may not be extended until the borrower repays these amounts as in clause.

(2) The loan terminates when: (a) Automatically, when its term is up; (b) The borrower and creditor agree to terminate it under the terms of part (1); (c) Automatically, upon a [significant change of ownership or control of the borrower].

(3) This terms of this clause (A) may not be modified except by court order on application of the lender.
6.2.2009 12:27pm
DeepThought:
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.

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.
6.2.2009 12:29pm
martinned (mail) (www):
@Lior (and others): If this is "government strong-arming", what do you call the methods by which American prosecutors are allowed to extract plea bargains? (Like in this recent Volokh thread.)
6.2.2009 12:30pm
zuch (mail) (www):
Prof. Anderson:
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.
You could put in a clause that restricts any deals with the gumnmint, and then they can go belly up on their own with no gummint intereference.
[from update]: 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.
You might just draft covenants that say that anything that the company does that's bad for your interests as a bondholder is prohibited to the company. That should cover this and any other unfortunate and unwise eventualities, and make sure the company execs toe the line .. and kiss your feet and ring before they even order copy paper. That will do much to ensure the value of your investment. I see no problems. Why this hasn't occurred to bondholders before is beyond me.

Cheers,
6.2.2009 12:31pm
martinned (mail) (www):

Bonds should be callable if a company receives any government aid: loans, subsidies, or benefits.

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.
6.2.2009 12:31pm
A. Zarkov (mail):
"But even if the agreement was coerced through political pressure, it's legally still agreement, right?"

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.
6.2.2009 12:46pm
KenB (mail):
Zuch says: "You might just draft covenants that say that anything that the company does that's bad for your interests as a bondholder is prohibited to the company."
That's more or less what a "material adverse event" clause does.
Martinned says: "Wouldn't it make more sense if bonds were callable when something happens that adversely affects their value?"
See above.
6.2.2009 12:52pm
martinned (mail) (www):

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.

...At least during police interrogation there are no guns in the room when the defendant agrees to plead guilty to a lesser charge.
6.2.2009 12:56pm
Larry Sheldon:
IANAL, so I can't see how you can write features into a contract that are worth the cost of the soybeans that died so you can write it when one side has the guns and the willingness to ignore what ever was written.
6.2.2009 12:59pm
martinned (mail) (www):

...when one side has the guns and the willingness to ignore what ever was written.

I thought we agreed not to be hysterical?
6.2.2009 1:01pm
Jim at FSU (mail):
>I haven't inserted it often, and have never even thought about trying to enforce it (Montenegro or Macedonia? Zimbabwe? Indonesia?).

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.
6.2.2009 1:09pm
Bart (mail):
I would suggest that any contract provision reacting after the fact to government intervention seeking to void the debtor company's contract obligations would be similarly voided and this meaningless.

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.
6.2.2009 1:17pm
Curt Fischer:


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.



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.
6.2.2009 1:28pm
Blue:
If I were advising a client on this subject for foreign bonds, I would suggest two things:

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.
6.2.2009 1:30pm
Bart (mail):
Blue:

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?
6.2.2009 1:35pm
Justin (mail):
Wow. The comments have certainly taken an "interesting" turn.
6.2.2009 1:42pm
H-Diddy:
Its interesting to me that the discussion here is about what do you add to your contracts to protect from the political risk that the contract won't be enforced. In negotiating deals in countries where contracts are less likely to be enforced I've observed that (i) the contracts tend to be much shorter and less precise than standard U.S. contracts and (ii) the non-U.S. attorneys are not nearly as interested as their U.S. counterparts in paying careful attention to the precise wording of the contracts. Put differently, I hypothesize that in countries in which contracts are less likely to be enforced parties spend less resources on crafting precise contracts in the first place. As to answering your question, I think that the commenters who have suggested charging a higher price for the money have it correct. Note that providing for international arbitration or the like won't help you if the borrower only has property in the jurisdiction you're worried about.
6.2.2009 1:52pm
corneille1640 (mail):

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.

So.....Obama threatened to kill the bondholders?
6.2.2009 1:59pm
A. Zarkov (mail):
Curt Fischer:

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.
6.2.2009 2:07pm
Maria S (mail):
Rather than trying to change the terms of secured bonds, use a different mechanism in the future. Use a sale and leaseback in which specific assets (e.g. land, machinery, buildings) are sold to the lessor at Fair Market Value. The lessee makes periodic payments equal to depreciation plus interest. The lessor can be a pool of owners and sell their individual shares on an open market.
6.2.2009 2:16pm
Connie:
Rich Teerlink, retired CEO of Harley-Davidson, writes (no, actually BRAGS) in his book More than a Motorcycle that in the 1980s the then-execs of the company borrowed money and "we violated the covenants before the ink on the agreements was dry" (covenants that had to do with the maintenance of certain guaranteen levels of security).

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.
6.2.2009 2:25pm
martinned (mail) (www):
@Connie: That depends on who is on the other side of said covenant. If the lender is the company's house bank, who know the company better than it knows itself, or even an other major Wall Street player, then you'd better believe those covenants are obeyed to the letter.
6.2.2009 2:30pm
Edmund Unneland (mail):
With regard to the bondholders, remember that many of them are fiduciaries for individuals who are saving (for instance) for retirement and educational expenses. President Obama's assertion that a Chrysler bankruptcy would be "controlled" shivered my timbers.

Ultimately, the problem was the fecklessness (in this instance) of the Bush administration.
6.2.2009 2:31pm
zuch (mail) (www):
KenB:
[zuch]: "You might just draft covenants that say that anything that the company does that's bad for your interests as a bondholder is prohibited to the company."

[KenB]: That's more or less what a "material adverse event" clause does.
I understand that. What I was obliquely pointing out is that this is a general problem (and not something specific to gummint interventions). But there's a price to pay as well for restrictive bond covenants ... and you'd think that those that think that gummint can't run their business ought to be just as leery of bondholders doing so. The more explicit the covenants are, the less flexible the business is. And while it's nice to prohibit (or punish) "material adverse event[s]", it's hard to see how such could be set up in advance to forestall specific disasters (while not preventing at the same time the needed flexibility to forestall any such other events not related to such a perceived "threat").

Cheers,
6.2.2009 2:39pm
Piano_JAM (mail):
Seems like in addition to a higher interest rate, one could have the bond issuer purchase some sort of 'put option' payable to bondholder as insurance.
6.2.2009 2:47pm
martinned (mail) (www):

Seems like in addition to a higher interest rate, one could have the bond issuer purchase some sort of 'put option' payable to bondholder as insurance.

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.
6.2.2009 2:50pm
hymie (mail):
Corporate bonds are market-traded instruments which rise and fall in value with the perceived risk that the company will default on its debts. Risk comes in many forms, and by the time a government intervention is at hand, the bonds will anyway be nearly worthless. Those widows and orphans whose pension funds held the bonds had already lost nearly all of their value. Most of the Chrysler bond holders who complained about the government intervention were in fact specialist funds which buy up such distressed bonds at scant pennies on the dollar, hoping that they can recover a few pennies more. There's nothing wrong with that, but it's inherently a very risky business, and there's no need for others to mourn their losses any more than to cheer their profits.
6.2.2009 3:24pm
jalrin (mail):
Kazinski,

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.
6.2.2009 3:47pm
martinned (mail) (www):

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.
6.2.2009 4:43pm
Kazinski:
Well then just make the bonds callable at the discretion of the holder. It's not like a distressed company that would be vulnerable to unionization is going to have much of a choice when obtaining capital.

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.
6.2.2009 4:58pm
David Welker (www):
Kenneth Anderson,

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.
6.2.2009 5:22pm
Kazinski:

Most of the Chrysler bond holders who complained about the government intervention were in fact specialist funds which buy up such distressed bonds at scant pennies on the dollar, hoping that they can recover a few pennies more. There's nothing wrong with that, but it's inherently a very risky business, and there's no need for others to mourn their losses any more than to cheer their profits.



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.
6.2.2009 5:29pm
jalrin (mail):
Kazinski,

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).
6.2.2009 5:31pm
Lior:
@martinned:
If this is "government strong-arming", what do you call the methods by which American prosecutors are allowed to extract plea bargains?


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.
6.2.2009 5:58pm
martinned (mail) (www):
@Lior: That's the part about this story that I don't get. Maybe I just just read up. What exactly is Obama supposed to have done to "strong-arm" these bondholders? Presumably a dire picture was painted of how much worse off the bondholders would be if they got in the President's way, similar to how prosecutors tend to list the charges and severe prison sentences they'll seek if the defendant doesn't plead. But in both cases (or, if you will, in neither case), it is still a "bargain". Despite the tone of prof. Anderson's original post, I'm not aware of anyone being forced to agree to anything. The bondholders could have insisted on their contractual rights, if they had been so inclined.

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.
6.2.2009 6:15pm
[insert here] delenda est:
Jalrin, how remotely can NLRB go? I confess complete ignorance of this area, but agreeing to repay your bonds does not immediately strike me as 'interfer[ing] with, restrain[ing[, or coerc[ing] employees' in anything. After all, if the premise is that unionisation is at worst neutral (and it appears implicit in 29 USC 158 in general that it is) then how can it be - one would be able to refinance, logically, on the underlying premise?

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)?
6.2.2009 6:21pm
MikeS (mail):
Not buying bonds from a company headed for bankruptcy is a start. Absent that, unless it can be shown that the bondholders are worse off than they would have been in a bankruptcy that didn't involve the loans that the government is making, this is simply the sort of whining that makes the investing class so generally despised.

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.
6.2.2009 6:49pm
Kenneth Anderson:
At this stage, I don't plan to get further into the discussion of the downsides to the senior and secured creditors. Whether they were 'strong-armed', as I said, I might be persuaded that it is too strong, but I recommend this news article as a starting place, from the news pages (not opinion pages) of the WSJ, 11 May 2009, "US Forced Chrysler's Creditors to Blink," and it uses the term 'hardball' tactics by the president. Strong arm too strong? I don't know, and think there's a limit on how much the terms are worth discussing. But as to the stakes for the senior and secured creditors, this gives a pretty good starting point.
6.2.2009 7:03pm
Tatil:
Once again, those with large amounts of money is pleading poverty and the media, including this blog, keeps talking about this "tragedy" even though there is no evidence of any more value available for the bondholders without government action. However, there are 20 billion dollars worth of evidence that the taxpayers are being shafted.
6.2.2009 7:05pm
Lior:
martinned: Obama didn't threaten to draft the bondholders and send them to Iraq, or have the IRS audit their books. But he did threaten them with "public humiliation". The bondholders could have insisted on their contractual rights, but would have had to live with POTUS naming them in public and calling them "bad people".

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".
6.2.2009 7:09pm
martinned (mail) (www):
@prof. Anderson: I'm sorry, but the point of capitalism is that we know that no one is getting sh*fted (to use Tatil's word) if all parties voluntarily agree to the terms. So the degree to which the bondholders voluntarily signed up to this deal is the essential question.

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.
6.2.2009 7:14pm
martinned (mail) (www):

Obama didn't threaten to draft the bondholders and send them to Iraq, or have the IRS audit their books. But he did threaten them with "public humiliation". The bondholders could have insisted on their contractual rights, but would have had to live with POTUS naming them in public and calling them "bad people".


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.
6.2.2009 7:26pm
David Welker (www):

Obama didn't threaten to draft the bondholders and send them to Iraq, or have the IRS audit their books. But he did threaten them with "public humiliation".


In a free country like America, there is no guarantee that when your investment decisions will not be subject to criticism. Deal with it.
6.2.2009 8:13pm
David Welker (www):

I would certainly agree that the bar for unconscionability should be lower if we're talking about the government.


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.
6.2.2009 8:40pm
martinned (mail) (www):
@David Welker: There are two reasons why I made that claim. Firstly, unconscionability is always requires a significant difference in bargaining power between the parties. Since they don't come any more powerful than the government, it should be extra careful lest it abuse its bargaining power.

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.)
6.2.2009 9:12pm
David Welker (www):

Since they don't come any more powerful than the government, it should be extra careful lest it abuse its bargaining power.


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.


Secondly, the government is a creature of law, created by the people to serve the common good.


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.


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.)


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.
6.2.2009 9:23pm
martinned (mail) (www):
@David Welker: I agree that it is a context specific question. I also agree that the government acted properly here, as far as I can tell. (I mentioned unconscionability a few comments earlier as an attempt to turn a hissy fit I don't agree with into an actual non-frivolous legal argument.)

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.)
6.2.2009 9:38pm
David Welker (www):
martinned,

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.
6.2.2009 9:48pm
Gabriel (www):
"How is it possible for this thing to be triggered automatically and at the same time impossible to untrigger?"
"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.
6.2.2009 10:15pm
martinned (mail) (www):

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

What would Chase's consideration be?
6.2.2009 10:26pm
martinned (mail) (www):
P.S. The reason why I'm asking is that this kind of thing often comes up in the kind of economics that I do for a living. "Is it possible to make a contract renegotiation proof?" While clever minds have considered this, the general view is that it is not.
6.2.2009 10:29pm
Gabriel (www):
martinned,

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.
6.2.2009 10:51pm
FriendlyNeighbor (mail):
The "Cuban Situation" joke.

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."
6.3.2009 12:08am
martinned (mail) (www):
@Gabriel: For Chase to be able to go to court and enforce the contract, it has to give something in return. That something is called consideration. Giving a single dollar may very well not be enough, on the grounds that it is only nominal consideration. After all, the contract has to be watertight, otherwise the party being restrained will sue to get out of it.
6.3.2009 3:47am
ohwilleke:
If Chrysler secured bondholders were more concerned about political risk, they could have obtained conversion or warrant rights that would have given them control upon the failure to Chrysler to meet financial conditions.

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.
6.3.2009 3:19pm
nick:
Among the various explanations of why the GM and Chrysler bondholders seem to have irrationally given up their legal rights, one that is missing is the possibility that many of the major bondholders of GM and Chrysler owned credit default swaps on this debt. Unlike, for example, your car insurance, these CDS's AFAIK lack clauses transferring the legal right to collect the debt to the CDS counterparty. If so, the counterparty has no standing in bankruptcy court as a creditor and the creditor has little incentive to enforce his rights -- he gets paid either way.

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.
6.3.2009 3:57pm

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