TARP: The Tragedy Deepens
Michael’s post immediately below deserves to be addressed in some more detail. Not only is the TARP program pernicious to the banking and financial sector, but it’s implications go much deeper than that, and corrupt the rest of the economy as well. And most importantly, this is only the beginning.
The corruption expresses itself in a number of ways. Take a look at the GM/Chrysler situation. In both cases, the UAW emerge as the clear winners in the bankruptcy proceedings. In the case of GM, bondholders with $27 billion in bonds are supposed to accept 10% of the company’s equity, while the UAW’s retirement fund, which holds $10 billion in bonds, is supposed to receive 40%, with the Government taking the remainder of the equity. In what possible way is this supportable?
Likewise, in the Chrysler bailout, the UAW will receive 55% of the equity, while Chrysler’s bondholders receive 30 cents on the dollar for their $7 billion investment.
OF course, Chryslers bondholders are balking at this, throwing the compnay into banklruptcy court. Not that that will save them. Why? TARP. As Thomas Cooley explains:
Chrysler’s dissident lenders have on their side the “absolute priority” bankruptcy rule, which holds that value must be distributed according to the legal priorities of the stakeholders.
Unfortunately, the bankruptcy code also holds that the absolute priority rule can be modified if a two-thirds majority can convince the court that it makes legal or business sense. Two-thirds of the lenders can force the holdouts to go along with them in a procedure called a cram-down.
That is exactly what is likely to happen. Citi, JP Morgan Chase, Goldman Sachs and Morgan Stanley, all major recipients of TARP Funds, all deep in the pocket of the Treasury, agreed to the administration’s plan.
So, the government, holding TARP over the heads of the banks, can now abrogate the generally used bankruptcy rules, and force through a sweetheart deal for a favored political client, the UAW. But, in so doing, they enlarge the damage to the country’s economy by sounding a warning that government funds are dangerous because the government’s first priority is to re-write the rules to reward their special friends. The uncertaintly that creates keeps investors on the sidelines.
Many investors are sitting on the sidelines, as is much money. Why? Because it is impossible to know what the rules of the game are. And that’s because the administration and the Congress keep changing the rules in capricious ways in pursuit of larger political objectives.
Megan McArdle make some of the same points, highlighting the danger inherent in such an approach by the government.
Countries that use their banking systems this way don’t get good results. If you’re a fairly uncorrupt developed country, you get slower growth and bloated “critical” sectors that are usually more critical in providing campaign support, lavishly remunerated make-work jobs, and photo ops, than any products the public actually wants. Then, if something like Japan happens, you have a twenty-year “lost decade” while everyone pretends as hard as hard can be that everything is all right, in the sincere but misguided believe [sic] that wishing hard enough will make it so.
One wonders if Ms. McArdle now thinks back on her support of Mr. Obama during the last election as “sincere but misguided”. But I digress.
IN any event, the government has moved full steam ahead with the approach Ms. McArdle decries. And it will continue to do so. How do we know this? because of the way the Chrysler bankruptcy is being handled.
I heard repeatedly from progressives, in the run-up to the bankruptcy case, that the holdouts were unreasonably holding out for a trivial improvement–about 500 million dollars. But if it was so trivial, why didn’t the government just put the extra money in, rather than jeopardizing confidence in the bankruptcy system–and the creditworthiness of a large swathe of unionized firms? $500 million is about the price of one cup of coffee per American, a trivial sum relative to the overall budget. This move has shown potential partners that government funds are dangerous, and potential lenders that union firms are risky bets; both have probably cost American citizens more than they saved. So why did the government risk so much for so little gain?
You know the answer, don’t you? Because they’re planning to do it again.
And to the extent they keep doing so, and keeping the financial sector in line via the TARP funds, investors will increasingly keep their money out of the game. Why should they do otherwise? Any investment in any entity with any relationship to TARP, either directly, or via creditors, is a target for the government to re-write the rules of investment and bondh0lding to ensure their special friends get a nice cut of the action.
True, it’s hard to have much sympathy for either GM or Chrysler. But the issue now goes far beyond them. Cooley, again:
There is at least some poetic justice in this outcome. The unions, whose years of work rules, and pension and health care deals helped sink the company, will have to eat their own cooking from now on. But their future success needs not only labor but capital.
Why would private capital get involved when the rules of the game are so capricious? No one would take that gamble when it is clear that, in dealing with the government, private capital will always take a back seat to politically powerful entities.
And that is the larger worry that current policy has neglected. Firms and markets can function quite well within a framework of rules. Indeed, rules are good for the orderly conduct of business. But when rules get imposed or dispensed with willy-nilly in the interests of politics, it is very dangerous. We have should have learned this lesson long ago.
But, apparently, we didn’t. Don’t worry, though. I’m fairly certain we’ll re-learn it in due course.
What really offends me the most in all this is not that the government is acting in the interest of favored clients, although that’s extraordinarily offensive. That’s what governments do.
I think the thing that offends me the most is the sheer stupidity of the thing.