Governments have unique power over credit markets. If a private party, provided that you live in a reasonably well-functioning democracy, the government will make him pay--or at least, set out the terms by which he can avoid doing so. Saying, like Bartleby the Scrivener, that "I would prefer not to" is usually not considered sufficient.
A government, of course, can default whenever it wants, under any terms it wants. It is limited only by the prospect of future difficulties in borrowing money.
But in times of duress, politicians--especially in emerging markets--are willing to deal with that comfortably far-off possibility, rather than find the money to pay the creditors now.
One of the big whiffs of my career--and every journalist has one of these eventually--was the time I wrote and filed a piece stating that Argentina was of course not going to default on its debt to the IMF, because that would be so obviously, phenomenally, stupid. Three hours later, Argentina defaulted on its debt to the IMF, and I stayed up half the night rewriting.
I also wrote that I thought it probably wouldn't actually make good on its threats to squeeze its foreign creditors down to less than thirty cents on the dollar, because that was so clearly going to starve the country of capital as it tried to recover from a financial crisis. Argentina willfully flouted my impeccable reasoning, and wrote its foreign creditors down to less than thirty cents on the dollar. I call that spite.
And for a while, it all seemed to be working. The world had a commodity boom, and Argentina, which grows a lot of commodities, boomed right along with it. Plus, countries recovering from a financial crisis always grow fast, because the contraction was so brutal. Between 2003 and 2007, Argentina averaged 9% annual growth, and the country did a very respectable 7% in 2008. It would take a stricter libertarian than I to deny that shedding that burdensome foreign debt at such attractively low rates probably helped the country grow back towards trend.
Unfortunately, when we sneeze, the developing world catches cold. Lengthened unemployment and great personal unhappiness here translate into malnutrition and physical suffering in middle-income countries. The government is running out of money--not in the vaguely doom-ridden sense in which you and I talk about coming Medicare deficits, but in the sense that it is now looting its pension system because that's the only remaining source of ready cash. All emerging markets are worried because the volume of borrowing in the developed world may absorb all the ready funds, crowding out emerging market borrowing. But Argentina has no access to the credit markets at all except through state agencies with real assets. That means that it may very shortly have to run an aggressively contractionary fiscal policy in a contracting economy. Financial assets are fleeing the country, and the yield on its existing debt has risen to levels that signal a horrifyingly high risk of default.
What Argentina did wasn't different in kind from what other emerging markets have done. It was different in degree. It bought short term prosperity at long term risk. Argentina didn't use the respite to build a more productive economy; it used it to do social spending that kept the Kirchner's in power. Now its citizens will pay the price.
The other night, I had dinner with someone who said that he wasn't that worried about the Chrysler interventions, because after all, memories in finance are short, especially when a financial crisis is involved. And he has a point--if he didn't there wouldn't be any emerging debt markets. But I have two questions. First, how short? Argentina's creditors show absolutely no signs of forgiving and forgetting. Its own citizens won't lend it money directly. And second, is this really true? When capital wasn't badly impaired and the disasters were short lived, perhaps investors shrugged it off and went back for more. But memories of the actions of both banks and private actors surrounding the Great Depression seem to have persisted more than a generation.
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But memories of the actions of both banks and private actors surrounding the Great Depression seem to have persisted more than a generation.
I hope you don't mean the Great Depression here. Because that surely was forgotten. Why do you think we have the crisis here in the US?
I hope you don't mean the Great Depression here. Because that surely was forgotten.
Um... The Great Depression was three generations ago.
I think it is cliche but true to observe that a lot of the "short memories" can be traced to whether the default actually fixed the fundamentals. So, for example, if a series of bad decisions or bad luck leads to a company going bankrupt, but the basic business is sound, then I would be surprised not see credit freely given. Heck, in a lot of cases a bankruptcy can improve your credit score for sub-prime credit products.
But the problem is that lenders need to be convinced that these problems will not recur. This forgetting requires either a good story as to why the default erased a "one time" issue or people to forget about the risk.
But, with Chrysler, the good story is in the opposite direction and the debtors will probably demand higher rates to compensate for risk (as the long term viability of the industry is in doubt). So I would not be surprised if not defaulting was a competitive advantage for Ford in the short term.
Megan,
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Floyd Norris wrote a piece for the New York Times titled Why Chrysler’s Bondholders Should Stop Whining, which to date I consider the only good piece to explain why perhaps the government was justified in the way it has attempted to manhandle Chrysler's creditors.
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His argument was that 1. The estimates by secured bond holders on what they'd receive in liquidation was pure negotiating propaganda (do I have any takers for a shuttered auto plan in Michigan?) and 2. The government loan is essentially a gift, and when you give a gift you get to decide how you want it distributed.
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I'm interested in hearing your thoughts.
Norris' column seems to hinge on two points:
1) The complaints of the financial class are solely premised upon the government backing out of the deal and allowing Chyrsler to move into bankruptcy court.
2) The government's cash infusion into Chrysler is equivalent in all evident respects to a private philanthropist giving aid to public health entities in a third-world nation.
If either of those points has flaws, Norris' column is at risk of coming unhinged. In my estimation, the first one is half right at most, and the second requires a substantial quantity of alcohol to support it. Or in other words, the gate is hanging at a crazy angle and the dog is halfway down the street.
I don't think you have to say that the Chrysler infusion is "equivalent in all evident respects to a private philanthropist giving aid to public health entities in a third-world nation" in order to argue that the government is under no obligation to treat all creditors equally. A normal DIP seeks to maximize return on investment, but they are certainly under no legal or moral obligation to do so. If I somehow purchase a company tomorrow simply because I like their logo the smart thing to do would be to attempt to maximize the value of that company. If, on the other hand, driving the company into the ground causes me to derive some form of strange pleasure, who is to say no?
The government is the only entity offering Chrysler a loan at this point. If instead of maximizing the chance of being repaid this loan the government chooses to maximize the value to a Chrysler creditor, well, why not?
I certainly don't think that's a prudent use of taxpayer money, and I'd vote against anyone who supports such a plan, but that doesn't mean I think bond holders are getting the short end of the stick. Bond holders are getting a fair offer, the UAW is getting an offer that is much more than fair, and the taxpayer is getting the short end of the stick. But giving a gift to the UAW doesn't somehow obligate the government to also give a gift to bondholders.
The bigger problem is the argument that the government loan has somehow improved the bondholders' chances of recovery. That's not at all clear--indeed, by ensuring that the bankruptcy occurred deeper into the crisis, it may have made things worse. At best, it was probably a neutral cash burn. So I can't see why the bondholders owe the governmetn much.
Beyond that, secured creditors don't get written down just because someone else put money in after them. Seniority of claims relies on debt covenants and the type of debt, not chronology.
With regard to your first point, Chrysler does have a variety of assets that have value. The Ram and Jeep nameplates still have value and the billions of dollars worth of unsold inventory on their balance sheet could certainly find potential buyers.
With regards to the claims that the government loan is a gift that they can spend how they wish, there is some validity to that general idea. However, there is a process that exists for how such a loan is given. The government is trying to subvert that process and reward lesser creditors of the corporation. If the government had truly played hardball with all the various creditors of Chrysler instead of primarily the secured creditors, the arguments of the secured creditors would probably be a lot less compelling.
I'm wondering how the history and development of the United States would have been different without the influence of Alexander Hamilton. How would our history have been different if we had reneged on our Revolutionary War debt?
My other question, for anyone who may know, what as the average Argentinian's explanation for their countries poor economic performance.
Argentina will do what it has always done when faced with this situation- it will inflate like crazy.
Sorry for the thread hijack, but a secondary but important question getting buried in the debate is ... why is it good for taxpayers (who will own a minority stake) to leave their fate in the hands of a union-controlled company?
Isn't that having the fox guard the henhouse? How can Barack Obama possibly expect that the UAW, the guys who are helping to kill Chrysler, would run Chrysler better than previous management? Why is Barack Obama throwing the remaining billions of taxpayer dollars to this special interest group? How would these guys turn the ship around? How will having the union call the shots make the hard decisions to shed jobs and push efficiency?
If anybody has any illusions about how a union-controlled company will fare, re-read this. Hard to believe the NYT used to publish articles like this.
http://www.nytimes.com/2002/02/17/magazine/into-thin-air.html?pagewanted=all
Thank you for that outstanding article. That was a pleasure to read.
Note though that they used the Southwest model towards the end to show how things could be effectively managed, when a fresh start is allowed (i.e. a new company forming with the lessons of others' failures)
I don't follow the airline industry much, but it seems Southwest is still succeeding.
Excellent article - anyone reading this thread will find it a good use of ten minutes to read and ponder it.
I don't know about the rest of you, but I am rather amused by the UAW all of a sudden having a majority stake in Chrysler. Especially if, after all of Obamas meddling in the credit markets, they find it difficult to secure any new private financing and also if they find it difficult to sell their stake. Is the union going to negotiate with itself now? It might be good for them to have to worry about the financial health of the company (for a change), since they may be stuck with it for a while.
I suppose some will say that Chrysler will get any further financing they need from the government, but I suspect that this too has limits.
UAW ownership of Chrysler only works out if the majority of retiree benefits somehow are tied to the future of performance of the company. Otherwise, the UAW can simply extract maximum value before sending the company out to die.
"Argentina's creditors show absolutely no signs of forgiving and forgetting."
It's worth remembering that the 2001 default you mention wasn't the first time Argentina has defaulted on its sovereign debt. Also, I believe most of Argentina's foreign creditors did accept the haircut deal Argentina offered in 2005. Last month, there was an article in the FT about a novel plan proposed by a couple of Argentine attorneys to win over the holdouts. I mentioned it elsewhere at the time ("Green Energy from Bad Debt?").
How long are financial market's memories? It took upwards of 150 years before American municipal and state bonds could be sold in Europe, after the repudiations of the 1840s.
"And second, is this really true?"
Of course it is.
One of the most profitable customers that a credit salesman can have is a customer who is now flush with cash because a bankruptcy court has wiped out all of its debts.
That customer will now willingly pay even higher interest - because they're an even greater credit risk. But now, since they've been absolved of all the debt that other suckers took on, the deadbeat has plenty of cash to pay all that extra interest.
It's a GOLD MINE for a while. They key is to get in while the getting is good, and to get out before the deadbeat gets overextended again.
Highly profitable business.
You aren't considering the major detail of the required waiting period between bankruptcy filings (was 6 years, is now 8 for Chapter 7 personal bankruptcies).
These people become better risks right after a bankruptcy because they can't discharge new debts anytime soon.
The US government is doing things we caution "emerging markets" governments from doing
o change the deal after it is done - converting TARP to a bank nationalization scheme
o ignoring bankruptcy law to push favored junior creditorors - the UAW - ahead of others
o encouraging and arm twisting banks to "modify" (read forgive) considerable mortgage debt to such an extent that it violates the purchase and sale agreements under which the loans were securitized - thus an ex post facto expropriation of the MBS investor's property
Next? We will have state-owned-banks making directed lending to state-owned-enterprises (Citi must buy bonds from Fannie!,Timmy G says so) It is "safer"
Even in the 90s, I was watching first hand as Larry Summers and Co were (correctly) admonishing east asian against this statism that infantilized their credit markets. Looks like Summers's voice is being ignored. Who is Obama listening to?
Himself?
Derek
Who could possibly have forseen that, once the government got substantial control over the biggest banks and got involved in the bailout/takeover of the domestic auto industry, it would use its power in those areas to reward friends and punish enemies? How could anyone have guessed that this kind of issue would come up?
I note that neither the WPPSS repudiation in the 80s nor the Orange County chapter 9 in the 90s had any lasting effect on the muni bond market or on the particular type of muni issuer to issue debt.
However, I do think that unionized companies and pension heavy companies will have a harder time attracting capital in the next couple of years.
I think that so much of asset management compensation is tied to short term performance and so much of investment banking compensation is tied to placement (not collection) that these incentives explain why markets are quick to discount / forget sovereign risks.
If a private party, provided that you live in a reasonably well-functioning democracy, the government will make him pay--or at least, set out the terms by which he can avoid doing so.
Megan, the above sentence is positively Yglessian in its level of dysfunction.
I say to Argentina, which reneged on sovereign debt, which impacted my holdings:
SUCK ON THIS ARGENTINA!
YOU DESERVE WHATEVER YOU GET!
Thanks for decreasing my wealth!
LOL Myles...not a laughing matter I know...but I like your spunk.
Pretty soon we'll be shouting the same thing to our own government!
Reading these comments helps me better understand how Mr. Obama was elected President.
Institutional memories in finance tend to be lasting. And there's a big difference between a personal Chapter 7 liquidation vs. a business Chapter 11 reorganization vs. the repudiation of sovereign debt.
The depth and haste of our government's intervention in the economy should make any sane person's head spin. And these interventions will have long-lasting ramifications. We're not likely to follow in Argentina's footsteps (at least not in the next few decades), but we will likely repeat the history of every country that has squandered the world's confidence in its money: massive inflation.
We are not today so much seeing a rerun of the Great Depression as we are of the late 1970's.