Market exacts a price for bailout of unions

Nicole Gilinas:

THE next time he sees President Obama, Mayor Bloomberg should lay out how the White House's auto-industry bailouts have hit hard at US financial markets -- and so hurt New York's future.

To please the United Auto Workers union, the president hacked away at a key cornerstone of markets: respect for centuries' worth of precedent in bankruptcy law.

Why do markets care so much about bankruptcy law? As we've seen in the last two years, markets are about losses as well as profits. Investors know (or should) that they run the risk that a company will go bankrupt. But when a company declares bankruptcy, there's a clear system for dividing up losses among different kinds of investors, according to the risks they signed up for.

Shareholders take the biggest losses. After that, lenders and other creditors take losses, but according to a certain priority: For example, junior lenders (who get paid a higher interest rate to offset the risk) take losses before senior lenders.

It's vital that this process be nonpolitical: Emotions can run high in a bankruptcy, and politicians might be tempted to take advantage of those emotions. Yet the White House's control of the Chrysler and GM bankruptcies has inserted naked politics into these processes.

When Chrysler went under, the government provided new billions so it could operate. Then Washington used its money and power to subvert the normal, longstanding order of bankruptcy losses.

Most egregiously, the government used its financial and political power to protect one Chrysler creditor, the powerful United Auto Workers union -- at the expense of lenders who should have been paid before the union's claims got covered.

Why did so many of Chrysler's lenders agree to these concessions?

The lenders who had enough voting power to push the agreement through in the bankruptcy were the same big banks who took billions of dollars in government bailout money in the last months of the Bush administration. They're beholden to Washington.

The action -- and the government's pressure -- rattled smaller lenders.

George Schultze, manager of a small hedge fund, told The Wall Street Journal, "We lent money to Chrysler under a contract that gave us the first [claim] on its assets. There was no agreement that union members or other unsecured creditors could jump ahead . . . This is about contract and bankruptcy law, and upholding agreements."

The General Motors case has solidified this unsettling precedent: A union trust for retiree health benefits is likely to recover three times more of its claim than bondholders will -- that is, the politicians are helping the union skip ahead of its "place in line."

Washington says it imposed its conditions not as a political player but as a financial player offering new money, and that the big-bank lenders who agreed to this plan also did so for financial, not political, purposes.

Even if that were true, no one would buy it. There's no way to ignore the government's sheer power here.

All of which gives people considering investing in American markets something more to worry about, on top of all the usual financial and economic risks: the risk that a more politically powerful party will jump ahead of them in a future case.

Such "political" risks belong in less developed countries where cronyism trumps merit.

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This is a point I have been arguing since this deal was first revealed. The market place is not exacting a premium for borrowers with unions making those companies even more uncompetitive than they already were because of union contracts. I think Bloomberg probably suggested this piece as a way of getting a message to Obama that there would also be a political price in New York for his perfidy.