Over at Asia Times I have been maintaing a financial blog called Inner Workings. Most of the material is technical, but I posted a Jeremiad today about the end of the rule of law in American business that is generally relevant.
Don’t zombies come from places where they grow bananas?
Over a year ago (in a “Spengler” essay) I characterized Barack Obam as a third world anthropologist profiling the United States:
Obama profiles Americans the way anthropologists interact with primitive peoples. He holds his own view in reserve and emphatically draws out the feelings of others; that is how friends and colleagues describe his modus operandi since his days at the Harvard Law Review, through his years as a community activist in Chicago, and in national politics. Anthropologists, though, proceed from resentment against the devouring culture of America and sympathy with the endangered cultures of the primitive world. Obama inverts the anthropological model: he applies the tools of cultural manipulation out of resentment against America. The probable next president of the United States is a mother’s revenge against the America she despised.
Was that an exaggeration? We will find out, but Obama has gone a lot further than any of his predecessors toward making America a banana republic. I spent part of the late 1980s and early 1990s globe-trotting with the notion that the Reagan economic revolution could be exported. My then business partner, the late Jude Wanniski, had coined the phrase “supply-side economics” to characterize Robert Mundell’s economic recovery plan. Jude had sold the plan to Jack Kemp, as I wrote last week at the First Things blog after Jack’s sad passing.
We set out spread the supply-side gospel everywhere. I spent months in Mexico and Russia, and shorter visits to Peru, Nicaragua and other venues. For the most part it failed miserably: what was lacking was the rule of law. Contracts mean nothing in banana republics, or rather, they mean what the top honcho says they mean. No-one wil commit capital except on the basis of a political deal that establishes a monopoly. That’s why telephone calls in Mexico cost several time what they do in the U.S., and one of the world’s two or three richest men (telephone czar Carlos Slim) comes from a poor country.
Obama is proceeding on the banana republic model. As Edward Jay Epstein wrote last week at the Vanity Fair blog, “the Czar’s rules apply.”
Consider the sad case of Chrysler. Its troubles became manifest in 2007, when it was owned by the German auto giant, Daimler, and it was unable to come to terms with the United Auto Workers labor union (UAW). Rather than suffer more losses from an unfavorable union contract, Daimler decided to rid itself of Chrysler by handing over 80 percent of its ownership to Cerberus Capital Management, a private equity fund named after the mythical creature guarding the doors of hell
Chrysler then borrowed $10 billion from a banking syndicate, led by J.P. Morgan Chase, Citigroup, and Goldman Sachs, to fund its operations. The loan was secured by mortgages on Chrysler’s real estate, manufacturing plants, patents, and highly profitable brand licensing rights. (Jeep alone earned $250 million a year licensing its name to toys, clothes, and other products.)
The lenders assumed (incorrectly, as it turned out) that their secured loan, which was senior to any other Chrysler debt, would be protected even if Chrysler went bankrupt, since the iron rule of bankruptcy held that secured loans get fully paid before unsecured loans. Without this rule, financiers would be reluctant to lend money to corporations on their assets.
What these lenders had not reckoned on was the political power of the UAW, especially after the 2008 Democratic landslide.
[snip] The solution that the administration endorsed involved dividing Chrysler into two companiesan old Chrysler, which would be saddled with the debts, and disappear, and a new Chrysler, to which all the valuable assets would be assigned, including those that had been mortgaged to the senior secured creditors.
The major banks, of course, backed the administration. They are able to issue debt guaranteed by the FDIC at rates just slightly higher than the Treasury itself a quarter of a trillion dollars worth to date. They have the TALF plan to unload securitized assets, and the Fed providing a backstop bid in the trillions for structured product. They remain profitable thanks to the administration, which in effect dictates how profitable they can by telling them how much capital they need to old. They look very much like banana-republic banks operating under a government subsidy.
What about the other secured lenders to Chrysler? As Michael Barone wrote in today’s Detroit News,
But my sadness turned to anger later when I heard what bankruptcy lawyer Tom Lauria said on a WJR talk show that morning. “One of my clients,” Lauria told host Frank Beckmann, “was directly threatened by the White House and in essence compelled to withdraw its opposition to the deal under threat that the full force of the White House press corps would destroy its reputation if it continued to fight.”
Lauria represented one of the bondholder firms, Perella Weinberg, which initially rejected the President Barack Obama deal that would give the bondholders about 33 cents on the dollar for their secured debts while giving the United Auto Workers retirees about 50 cents on the dollar for their unsecured debts.
Non-cooperative lenders (that is, lenders not part of the big banking monopoly) received death threats. The White House is not making death threats, to be sure only threats of destroyed reputations but when the President of the United States denounces lenders as “speculators” in the midst of a painful economic downturn, he helps to create an atmosphere in which violence is not unimagineable.
It isn’t just Chrysler, of course. As I’ve reported before, loan modification, cramdown and so forth have destroyed investors’ confidence in the viability of collateralized mortgage lendng.
Nothing like this happened under Roosevelt, let alone Jimmy Carter. Obama has traded the loyalty of captive commercial banks for the rule of law in capital markets. It will take many, many years to undo the damage.