The Bailout and Why Corporate Bonds May Not Be a Safe Investment
The law is very clear. When a company goes into bankruptcy, stockholders and those who hold unsecured debt have to stand in line behind those who have secured debt. And corporate bonds are secured debt. This means that the people that own them are supposed to go to the head of the line to collect whatever is left over from a bankruptcy proceeding. But then along came the credit crunch, the bailout of automakers, and a lot of pressure from the Obama administration to rush Chrysler through its bankruptcy proceedings. These events have apparently changed the way that corporate bond holders are treated, and now there is no reason that any investor in their right mind should buy them.
The structure of the Chrysler bankruptcy deal – a deal that has been pushed through the courts with the help of President Obama – is downright strange. That is due to the fact that it has been engineered by politicians. Some of those with unsecured debt in Chrysler will wind up getting $0.59 on the dollar and own 55% of the company. But the company’s bond holders, the ones that are supposed to get the most, will only receive $0.29 on the dollar. Needless to say, some of the bondholders are not too happy about this. So they sued to try and stop the deal from going through. In order to accomplish this, they had to convince an appeals court panel to stop Chrysler’s merger with Fiat. Earlier today that effort appeared to day failed.
The three judge panel hearing the case agreed to halt Chrysler’s sale to Fiat until 4:00 PM on Monday. This is to allow attorneys to make an appeal to the Supreme Court. Their initial contact at the Supreme Court will be with Justice Ruth Bader Ginsburg who is responsible for overseeing the appeals court in New York. Justice Ginsburg will have the option of issuing a ruling herself or referring the matter to the full court.
If the Chrysler sale is allowed to go through, Chrysler will have permission to transfer its Jeep, Dodge and Chrysler brands to a new company and eliminate most of the company’s debts. Since these brands are the primary assets of Chrysler, such a transfer would leave anyone holding bonds or stock in the old company with virtually nothing – although it should be pointed out that bond holders will get some secured debt in the new company.
The ruling also paves the way for GM to do roughly the same thing. GM declared bankruptcy this past Monday.
The Obama administration appears to be focused on preserving jobs at GM and Chrysler. While that may be a fantastic goal, doing it in this way is likely to hurt large corporations in the future. Chrysler has received $2 Billion in TARP funding from the government to help finance the sale – something which attorneys representing the bond holders also said was illegal.
Large companies raise much of their funding through bond sales. Changing the rules of the game on bond investors is a great way to insure that these investors will find other areas of the market where their money is safer. If companies find that they are unable to raise capital through bond sales, over the long term both jobs and economic expansion will suffer.
The judges hearing the case relied on a portion of the bankruptcy code that allows companies to transfer assets when there is a time sensitive offer on the table; in this case from Fiat. The problem with this is, at least to the bond holders, Chrysler’s assets may have given them a greater return if they had been liquidated rather than moved to another company. Since many corporate bond holders are pension plans and individual retirees looking to bolster their income, this decision has a real impact on anyone who is or who is planning to retire any time soon.
One thing is certain. Before purchasing any corporate bonds investors should find out of the companies selling those bonds received any TARP money. If they have, you should walk away. The Obama administration is making it very clear that its motivations are more important than your puny investment… even if that puny investment is everything you own.
Politics & Politicians 
