Talking Down Auto Bondholders

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The government is trying to get GM and Chrysler bondholders to take a hefty haircut on their debt rather than push the companies into bankruptcy.  The problem is, it's a terrible deal for the bondholders, and there's no reason for them to do it:

The UAW has been largely unwilling to negotiate with GM until it sees what concessions will be made by bondholders and others.

The standoff between bondholders and the UAW underscores the difficulty surrounding GM's attempt to reorganize without the coercion of bankruptcy. Key players in the Obama administration are pointing to the lack of progress as a reason that bankruptcy could be unavoidable.

At Chrysler, the U.S. wants banks and investors who control its bank debt to give up about 85% of the nearly $7 billion they are owed. In bankruptcies, such senior secured lenders typically get most of their money back.

Some senior lenders believe they would get more than 70 cents for each dollar of their secured loans if Chrysler is broken up and sold under bankruptcy, said people familiar with the talks. Other lenders don't have an exact number nailed down and are awaiting detailed figures from the auto maker on its assets.

All of the 40-plus lenders and investors are nonetheless incensed by the last Treasury offer: that they accept about 15 cents per dollar of face value of their loans.

The government wants to keep the automakers out of bankruptcy because it wants to maximize gains for employees.  GM's pension, thank God, was actually overfunded last time I looked, so at least retirees won't lose the income they've planned on as so many do in these legacy industry bankruptcies--the PBGC fund top benefit is well under a little over* $50K per annum.  But the health benefits will probably vanish, as will a lot of jobs, and the union contracts all get torn up.

But it's trying too hard to maximize that value.  It has no credible threat of nationalization with congress in its current mood, so why would bondholders take a deal where they barely recover any of their money?  Social welfare might (might) be maximized by keeping these conpanies as big as possible, but I doubt the bondholders feel any personal obligation to bear that cost.  They've already lost at least 30 cents out of every dollar they gave the auto companies.

This is what modern American bankruptcy is for.  If you look at systems where senior creditors have too much power, there's evidence that they will screw the junior debtholders by taking the money and running, rather than trying to maximize enterprise value.  (Though, to be fair, there's also evidence that maximizing enterprise value entails much higher administrative costs.) The administration essentially has a hold-out problem, and unless it nationalizes, or sweetens the deal considerably, you need bankruptcy to resolve it.

The administration seems to be negotiating like a sovereign, which, of course, it is.  But GM is not.  Unlike Argentina, it can't just default and flip off the bondholders.  When it defaults, its creditors can put it into bankruptcy.  The administration seems to be trying to prevent that in order to preserve stakeholder value--but the recovery in bankruptcy is essentially the floor of what the creditors will accept.

Or maybe this is all some elaborate Kabuki ritual, where the government pretends to be talking tough in order to placate Big Labor, while quietly waiting for the inevitable.  Either way, it seems like a giant waste of time.

*  Sorry, folks; I was working from memory, and they've upped their maximum guarantee

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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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