When Obama Says “Hedge Fund,” Think “Widows and Orphans”

chrysler-winged-badgeAt least one of Chrysler’s “secured” lenders is vowing to stand fast against President Obama’s efforts to bully the lenders into abdicating their fiduciary responsibility.

NEW YORK (Reuters) – Plans for a quick sale of Chrysler to a new company majority-owned by a union-aligned trust is “patently illegal” and will be fought in bankruptcy court, one of the holders of the automaker’s secured debt said on Thursday.

“We don’t succumb to pressure and don’t agree to unfair and illegal payment schemes,” said George J. Schultze, the managing member of Schultze Asset Management. “We’re not conflicted by TARP money or active stress tests.”

Good for him.  I just hope he has bodyguards.

Obama is all too willing to stir populist anger in support of his favored constituencies.  It’s important to understand just how perversely Obama is framing the debate — and why his cram-down tactics make it less likely that future troubled borrowers will be able to raise the capital they need.

In criticizing the “hedge funds” that refused the terms that might temporarily have kept Chrysler out of bankruptcy court,  he said:

I don’t stand with them.  I stand with Chrysler’s employees and their families and communities.  I stand with Chrysler’s management, its dealers, and its suppliers. I stand with the millions of Americans who own and want to buy Chrysler cars.  I don’t stand with those who held out when everybody else is making sacrifices.

OK, Mr. President, I got it: hedge funds = bad, families and communities = good.  But at Pajamas Media, Tom Blumer reminds us that hedge funds manage money not just on behalf of rich people, but also on behalf of retirement funds, pensioners, college endowments and other constituencies that are every bit as much a part of the fabric of America as the UAW is.

He also describes the legal duty these secured lenders owe to the ultimate owners of the securities.

The Employee Retirement Income Security Act (ERISA), passed in 1974 with strong bipartisan support, subjects retirement plans to a very strict standard of fiduciary duty, specifically:

(1) … a fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and —

(A) for the exclusive purpose of:

(i) providing benefits to participants and their beneficiaries; and

(ii) defraying reasonable expenses of administering the plan

There is nothing ambiguous about this requirement and nothing about the word “solely” or the term “exclusive purpose” to misunderstand.

Mr. Schultze and the secured lenders are trying to protect their investors by enforcing the agreement that was made when the capital was supplied to Chrysler.  In a bankruptcy, secured creditors are entitled to recover 100% of their money before unsecured creditors receive a penny.  That’s the deal they signed up for, and that “security” is why they were willing to supply capital to a basket-case company.  That protection was baked into the terms of the funding agreements.

In Chrysler’s case, as in many bankruptcies, the secured lenders were willing to settle for less than 100%, even while letting the unsecured lenders share in the settlement, for the purpose of trying to nurse the company back to health.  Blumer explains:

In a normal bankruptcy, first-lien creditors get paid what they are owed before anyone else. Since assets rarely fetch their ongoing-use value in liquidation, it appears reasonable that Lauria’s group [the secured creditors] would have come down in negotiations from 100% to 65%, and then to 50%, in the interest of avoiding bankruptcy. Presumably, 50% is a reasonable estimate of what might be realized in liquidation.

But if the secured creditors think they can recover more money for their investors by forcing a liquidation, they have a fiduciary duty to do so.  If they don’t get a higher payout than the unsecured creditors, they are betraying their investors, and making it less likely that troubled companies will be able to raise capital in the future.   That’s what Obama is trying to force by demonizing the holdout creditors.

The big TARP-program banks that agreed to the Chrysler deal had already had their turn at being beaten into submission less than a month earlier, when Obama told their CEOs “my administration is the only thing between you and the pitchforks.”   In the face of that fairly explicit threat from the most powerful man in the world, it’s unsurprising that they would fall into line the next time push came to shove.  I’m just glad that at least one smaller, less conficted creditor is willing to stand up for the rule of law.