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Chrysler’s Mother of All Haircuts

Created 04/27/2009 - 11:41am

Let's just look at the numbers. Chrysler has three days to submit a viability deal to the administration's auto task force. A partnership with Fiat now looks likely, a triumph for Fiat CEO Sergio Marchionne [2] and his zero-money-down strategy to obtain control of the smallest of the Detroit automakers. The UAW, pending a membership vote, has agreed to chop its $10.6 billion benefits trust in half [3], taking half in stock. (The Canadian union has already accepted a similar deal.)

This leaves Chrysler's bankers and their $6.9 billion in secured debt, on which they have been exceptionally reluctant to take a haircut. The government's proposed terms have been rough: sacrifice $5.4 billion and take a 5 percent ownership stake. The debt holders want much more, but on Friday they signed onto the Fiat deal and abandoned efforts to get the Italian carmaker to kick in money. Meanwhile, the clock is ticking on General Motors' own deadline to resolve a similar set of issues: June 1. What happens with Chrysler's creditors will obviously be a roadmap for what GM's bondholders can expect.

In this game of bankruptcy chicken, it's worth remembering that putting money into Detroit in the last 10 years should have been a decision that investors thought through more fully in terms of risk. The transparency that has emerged over the past three months has exposed the domestic car industry's numerous competitive disadvantages. Of course, Chrysler's bondholders probably didn't count on a general finance-sector meltdown when they assumed that they'd be first in line for either bailout funds or the chance to carcass-pick the Pentastar and its desirable assets, such as Jeep, in bankruptcy. They ran into black swan [4], and they underestimated the Obama administration's political commitment to preventing an unemployment apocalypse in the Upper Midwest.

The irony here is, of course, that the banks involved have themselves taken billions in bailout funds. Now the government is playing tit-for-tat and insisting that they use some of that funding to subsidize the Chrysler deal. It's an ad-hoc, back-door phase-two bailout for the auto industry, making up for the miserliness of the first tranche, and in a sense leveraging the $6 billion that Chrysler-Fiat will receive if this week's viability plan is accepted. So the Treasury can operate just like a shrewd investment bank, too, when it's playing with the taxpayers' money. But unlike the embattled private sector, its ability to absorb risk is almost unlimited. Chrysler's debt-holders need to be careful over the next few days. A haircut could easily turn into a scalping.

Article: Chrysler’s Mother of All Haircuts
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