Obama abandons the rule of law in auto deal

Todd Zywicki:

The rule of law, not of men -- an ideal tracing back to the ancient Greeks and well-known to our Founding Fathers -- is the animating principle of the American experiment. While the rest of the world in 1787 was governed by the whims of kings and dukes, the U.S. Constitution was established to circumscribe arbitrary government power. It would do so by establishing clear rules, equally applied to the powerful and the weak.

Fleecing lenders to pay off politically powerful interests, or governmental threats to reputation and business from a failure to toe a political line? We might expect this behavior from a Hugo Chávez. But it would never happen here, right?

Until Chrysler.

The close relationship between the rule of law and the enforceability of contracts, especially credit contracts, was well understood by the Framers of the U.S. Constitution. A primary reason they wanted it was the desire to escape the economic chaos spawned by debtor-friendly state laws during the period of the Articles of Confederation. Hence the Contracts Clause of Article V of the Constitution, which prohibited states from interfering with the obligation to pay debts. Hence also the Bankruptcy Clause of Article I, Section 8, which delegated to the federal government the sole authority to enact "uniform laws on the subject of bankruptcies."

The Obama administration's behavior in the Chrysler bankruptcy is a profound challenge to the rule of law. Secured creditors -- entitled to first priority payment under the "absolute priority rule" -- have been browbeaten by an American president into accepting only 30 cents on the dollar of their claims. Meanwhile, the United Auto Workers union, holding junior creditor claims, will get about 50 cents on the dollar.

The absolute priority rule is a linchpin of bankruptcy law. By preserving the substantive property and contract rights of creditors, it ensures that bankruptcy is used primarily as a procedural mechanism for the efficient resolution of financial distress. Chapter 11 promotes economic efficiency by reorganizing viable but financially distressed firms, i.e., firms that are worth more alive than dead.

Violating absolute priority undermines this commitment by introducing questions of redistribution into the process. It enables the rights of senior creditors to be plundered in order to benefit the rights of junior creditors.

The U.S. government also wants to rush through what amounts to a sham sale of all of Chrysler's assets to Fiat. While speedy bankruptcy sales are not unheard of, they are usually reserved for situations involving a wasting or perishable asset (think of a truck of oranges) where delay might be fatal to the asset's, or in this case the company's, value. That's hardly the case with Chrysler. But in a Chapter 11 reorganization, creditors have the right to vote to approve or reject the plan. The Obama administration's asset-sale plan implements a de facto reorganization but denies to creditors the opportunity to vote on it.

...

What is surprising to me is that Zywiki's comments are not understood and comprehended by Obama and his finance team. It is should be obvious that the deal they are trying to cram down will undermine the economic viability of secured creditors and thereby undermine capital formation for companies.

It is important that this attempt be challenged not only in the bankruptcy court, but also in the court of public opinion. This blatant gift to the unions who were in part responsible for Chrysler's demise should not be allowed to succeed.

Kevin McDonald looks at some of the built in conflicts of interest for the government in the Chrysler deal. Not mentioned are the conflicts of interest for the UAW in negotiating with itself as well as negotiating with other auto makers like Ford while at the same time competing with them.