Credit Markets Doomed; Dow Headed to 36,000

Oh, goody, another dispatch from our financial betters in the New York Times: the Obama Administration is destroying the credit markets for the benefit of. . . wait for it. . . labor unions. This oh so frightening story comes to us from James K. Glassman, the author of a seriously wrong book, Dow 36,000. I guess writing a silly book about the stock market is an obvious qualification for a foolish screed on credit markets. His co-writer, Kevin Hassett, is equally hostile to the Obama Administration. Nate Silver does the honors.

Mr. Glassman tells us how badly the Obama Administration treated Chrysler’s debtholders, repeating the press distortions in the approved order. First, he tells us the Chrysler debtholders had the right to all the money, ahead of everyone. Glassman fail: they had the right to a bunch of empty factories. They also had the right to negotiate a deal with the only entity willing to lend money to the totally bankrupt company, the US Government. Turns out the debtholders were lousy negotiators. Too bad for them.

Then we find out that the reason for this horrid treatment of banks is that Obama has to reward his union supporters, whose legal claim, according to Mr. Glassman, is worthless. He then turns to the bankrupt GM, whose bondholders are unsecured creditors as opposed to the secured Chrysler banks. They got a lowball offer from the government, the only financier willing to salvage the company. The union, with a claim in about the same amount as that of the bondholders, gets a lot more.

An educated person would have started by recognizing that the alternative to a negotiated deal is bankruptcy. Facing that expensive and uncertain process, parties negotiate to determine whether they can get a better deal before bankruptcy than in Chapter 11. When GM files, the union is the beneficiary of 11 U.S.C. § 1114, which says:

(e)(1) Notwithstanding any other provision of this title, the debtor in possession, or the trustee if one has been appointed under the provisions of this chapter (hereinafter in this section “trustee” shall include a debtor in possession), shall timely pay and shall not modify any retiree benefits….

That gives them a stronger bargaining position than the other unsecured creditors, a fact which the President’s negotiators and, presumably, the bondholders, knew. That was true in the Chrysler case too, and it explains why the unions got a reasonable deal. Mr. Glassman could have found this out by reading Firedoglake, or he could have read Bloomberg, which quotes a really expensive lawyer saying the same thing, which I assume would have meant more to Mr. Glassman than a statute quoted by a much less expensive blogger.

The Bankruptcy Code favors retirement benefits for sound policy reasons. First, the Pension Benefit Guaranty Corporation is on the hook for losses in pension plans. Second, workers defer income into pension and health care plans. They earned their money by actually producing something. Bondholders were taking risks with capital, including the risk of bankruptcy. This is a known risk, and one which is priced into interest rates. It is one of the factors which is considered in academic thinking about the Modigliani-Miller Theorem (.pdf).

Sometimes when you take a risk, you lose. I realize how hard it is for our financial superiors to understand that this is a real possibility, but they need to get used to it. It is a rule that in disasters, everyone, even bondholders, takes a haircut.

Apparently Mr. Glassman can’t understand the difference between tough negotiations and strong-arming, so here’s an example. The Obama administration gave Judicial Watch the talking points Henry Paulson used when he met with the heads of nine giant troubled banks to get them to accept a bailout last October 13. Here’s a quote:

This is a combined program (bank liability guarantee and capital purchase). Your firms need to agree to both.

  • We don’t believe it is tenable to opt out because doing so would leave you vulnerable and exposed.
  • If a capital infusion is not appealing, you should be aware that your regulator will require it in any circumstance.

Translation: take the money or swim with the fishes.

Political discourse is irrational enough in this country, as the Sotomayor nomination proves. Financial matters are subject to real-world testing. James K. Glassman fails the empirical test: he was laughably wrong. Surely it isn’t asking too much of the New York Times to keep this ridiculous person out of the editorial pages.

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