Uncle Sam and the perils of ownership

The government’s large stake in banks including J.P. Morgan and Citibank gives rise to a basic conflict of interest when the government seeks to extract concessions from them as secured lenders in the auto bailout. How is the government resolving the conflict in the negotiations over Chrysler’s restructuring and possible integration with Fiat?

The government appears to be acting as an advocate of Chrysler in its negotiations with the banks, and even of specific interests within Chrysler. If the government were operating under the loose rules of professional responsibility that govern attorneys acting as advocates, the banks could require the government to step aside from the proceedings. The government being the government, however, it is free to demand concessions from the banks that are substantially inimical to the banks’ interests.

There is a surreal quality to the Wall Street Journal’s report on the government’s role in the Chrysler negotiations if one is aware of the conflicts of interest in the government’s position:

A group of big banks and other lenders rebuffed a Treasury Department request that they slash 85% of Chrysler LLC’s secured debt, proposing instead to eliminate about 35% in exchange for a minority stake in the restructured car maker and a seat on its board.

The lenders’ counteroffer marks a significant act of brinksmanship as the banks and the Obama administration’s auto task force duel over concessions to avoid liquidating the country’s third-largest car company.

Chrysler faces an April 30 Treasury deadline to seal an alliance with Italy’s Fiat SpA that also requires concessions from lenders, as well as from the United Auto Workers union.

Chrysler owes the lenders, which include Citigroup Inc. and J.P. Morgan Chase & Co., about $6.9 billion. But President Barack Obama and his auto team had requested that the banks cut that to $1 billion, while gaining no equity stake in a restructured Chrysler.

In their five-page counteroffer, which was sent to the Treasury late Monday, the lenders said they are prepared to cut Chrysler’s first-lien debt by $2.4 billion, or down to about $4.5 billion, in exchange for a 40% equity stake and a Chrysler board seat, according to a copy of the proposal provided by individuals outside the lenders’ group.

The lenders also are demanding that Fiat pour $1 billion in capital into Chrysler in exchange for whatever equity stake it would gain. That could be a source of conflict with the Italian auto maker, which has said it instead wants to give Chrysler only technology.

The Treasury shot back, making it clear that the government didn’t plan to accept the lenders’ proposed terms.

“It is neither in the interest of Chrysler’s senior lenders nor the country for them to advance a proposal that would yield them an unjustified return as Chrysler, its employees and other stakeholders are working tirelessly to help this company restructure,” the Treasury said in a statement.

“Our hope and expectation is that these lenders take a more constructive position in the coming days that reflects the actual situation that they and the company face,” the statement continued.

In making their case for a significantly smaller sacrifice than what the government wants, the lenders have argued that their fiduciary duty to their own shareholders and investors requires them to recoup as much as possible from the car maker. The lenders have told Treasury officials they believe they could recover at least 65% of their loans if Chrysler is liquidated in bankruptcy.

In the restructuring the government is seeking to engineer, the government assumes that the $4 billion it lent Chrysler largely will be wiped out, as will a combined $2 billion Chrysler owes Cerberus Capital Management LP and Daimler AG, Chrysler’s last two owners. The government would then put in an additional $6 billion to fund the operations of Fiat-Chrysler.

One senses that the government is not exactly operating as an impartial arbiter of the interests at stake in Chrysyler’s restructuring. The Journal reports that one assumption upsetting to some lenders was that Chrysler would pay about $3 billion total to a UAW retiree health-care fund in 2009 and 2010, which is owed about $10 billion and would also get an unknown amount of equity in the new Chrysler even though the fund is behind the banks, Cerberus, Daimler and the U.S. in the order to be paid.

Toward the end of the hard copy of the article in the Journal yesterday comes a memorable sentence that I don’t see in the article’s online version:

Many of the lenders were angered by the demands made by the head of the administration’s auto team, Steven Rattner, who wanted the banks to forgive $5.8 billion of the $6.9 billion owed them in exchange for nothing.

How unreasonable can you get? The article then quotes one of the bank participants in the negotiations: “What the government was asking for was completely without precedent in the history of bankruptcy in the United States. Our reaction to their proposal was, ‘Forget it.'”

The article fails to note the conflicts of interest in the government’s role in the Chrysler negotiations, perhaps because the government’s interest in the banks doesn’t appear to affect its position in the negotiations in an obvious way. The Journal makes up for this oversight in Holman Jenkins’s column on the government’s role in the auto bailouts. The government’s conflicts of interest do not escape Jenkins’s gimlet eye.

Jenkins asks: Wasn’t TARP supposed to be about restoring a healthy banking system? Isn’t that a tad inconsistent with banks just voluntarily relinquishing valuable claims on borrowers? Jenkins responds: Don’t ask.

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