It appears the White House is playing hardball with the auto industry's creditors as a negotiations continue in Washington's attempt to fix the beleaguered GM and Chrysler. One thing we have not seen with the bailouts of financial firms is an attempt to make creditors--investors--take a significant loss. While shareholders have often been left out to dry, the firms and groups making the big loans to businesses now in decline have remarkably been able to escape unscathed. For instance, AIG's creditors included Goldman Sachs, Citigroup, Wachovia, Societe Generale, Deutsche Bank, and Barclays, among others. They were all paid back for the money they lent to AIG with bailout money while AIG shareholders have been left with stocks worth barely a dollar.
But one has to ask why the creditors, who basically took an investment risk by loaning money to big firms like AIG, shouldn't have to suffer losses. By bailing them out completely it creates moral hazard for future investments, they've got to have skin in the game. (See also Economist Tyler Cowen talk about this here).
Somehow, though, the White House is taking a different approach with Big Three creditors:
The Treasury Department is pushing GM to offer its bondholders, who are owed $29 billion, a small portion of shares in the company. That's a sharp cut from a bond-exchange offer GM made two weeks ago... The Treasury, which has pumped $13.4 billion into GM to keep it afloat, believed the earlier plan was too generous to bondholders.
The fact is that creditors in general should take a loss, at least in some capacity, is a good thing. However, exactly what that should be is often a battle, and Washington doesn't exactly have the best bargaining position.
Earlier today Megan McArdle over at The Atlantic, made the point that creditors have little incentive to take the deal offered by GM: "[The government] has no credible threat of nationalization with congress in its current mood, so why would bondholders take a deal where they barely recover any of their money?" Creditors are almost certainly going to get a better deal in bankruptcy court.
The Wall Street Journal noted that:
At Chrysler, the U.S. wants banks and investors who control its bank debt to give up about 85% of the nearly $7 billion they are owed. In bankruptcies, such senior secured lenders typically get most of their money back.
Of course not everyone gets their money back in bankruptcy court, and its up to the judge and how contracts were set up. That's why firms are happy to take big bailout refunds of their money. Or in the case of Ford, if creditors think that a firm is taking the right path towards recovery they may accept and adjustment in how their debt repayment is structured after an analysis of what would bring them their biggest return.
GM and Chrysler have not displayed proof that they are headed in the right direction. And more and more it looks like bankruptcy is the best option for the two car companies. Its good that the government is playing hardball and not bowing low to the auto industry creditors, but at the same time, in this climate, this just might not be enough.