- The bulk of the people interviewed appear to have basically no clue about contracts and/or contract law
- President Obama has forgotten that "the point" of the Executive branch is the enforcement of US Federal law
The senior secured lenders to Chrysler are owed $6.9 billion. In order to really appreciate the actions of President Obama, we need to know what it means for a debt to be senior and secured.
We're gonna have to start by defining some terms. Otherwise, you could hit the far end of this article not one bit more aware of what's coming than the morons in the media. That's not acceptable.
Secured Loan / Secured Debt
In a secured loan, the borrower pledges some asset as collateral for the loan -- making this a secured debt for the lender. If the borrower defaults on the loan, the pledged asset becomes the property of the lender. Your car loan is a good example: if you stop making payments, the lender has the right to take THEIR car back. Because the lender has the right to the pledged asset in the event of default, secured loans are less risky and tend to be available at relatively low interest rates.
Unsecured Loan / Unsecured Debt
An unsecured loan is one where the borrower does not pledge any asset as collateral in the event of default -- making this an unsecured debt for the lender. In the event of a bankruptcy, unsecured debts have a general claim on the assets of the borrower AFTER the secured debts have been paid. This places unsecured creditors at a higher risk of loss in the event of default, which tends to result in significantly higher interest rates for unsecured loans. Your credit card is an example of an unsecured loan.
A senior debt is one which takes priority over other debts owed. In the event of a bankruptcy liquidation, senior debts are paid first. Because of this reduction in risk to the lender, senior debt tends to be less expensive, (lower interest rate), than debt that has a lower repayment priority. Your home mortgage has a senior claim on the house.
These differences are why your home mortgage rate is between 5 and 7 percent, and your credit card is between 10 and 33 percent.
Back to the matter at hand.
The senior secured lenders to Chrysler are owed $6.9 billion. By law, these lenders have first dibs on the pledged Chrysler assets in order to satisfy this debt. There are only two legal provisions to change this:
* either both parties agree to a change in the terms of the loan,
* a bankruptcy judge changes the terms of the loan.
Obama's team has offered to pay these senior secured creditors $2.25 billion for their $6.9 billion claim (32.6 cents paid back for each dollar of senior secured debt).
Some of the senior secured creditors have taken this offer. In particular, those banks who were recipients of TARP funds have agreed.
What I find to be especially appalling is that the US Executive branch is villifying those people who hold a valid contract and aren't even so audacious as to insist on its enforcement. These "holdouts" are asking to be paid 36.2 cents for each dollar of senior secured debt.
It is President Obama's job to enforce US Federal law. His attempt to stir up popular sentiment against those whose legal rights he doesn't like is at odds with his sworn duty.
One of the senior secured lenders who originally was holding out for 36.3 cents on the dollar was Perella Weinberg. They changed their position after they were threatened that the full force of the White House press corps would destroy their reputation if they didn't agree to the lower payout rate.
That isn't enforcing the law, that's thugocracy.
You might be wondering if there are any long term consequences to this whole fisaco. If you aren't you should be -- unless you don't think it takes much wondering.
Think back to the definitions at the top of this. Certain types of loans are less expensive because of their inherent risk to the lender. If a lender can't trust that a secured claim will be enforced, their risk exposure isn't being meaningfully improved -- that means the loan will be more expensive unless they are just completely stupid.
President Obama says he wants to get the credit markets "working again". Maybe he should stop kidney punching their legal underpinnings.
What do you think your next mortgage rate will be if lenders are taught that their senior secured debt will be treated like (or worse than in the case of the Chrysler mess) a lower-priority unsecured debt? Do you really want to pay 20% interest on your next home loan?
What about your favorite "small business"-- vintage clothing store, coffee shop, ethnic restaurant? What are the odds that they can secure relatively inexpensive financing if pledging their assets as collatoral doesn't reduce the interest rate they pay on their operating line of credit? Will there be new "little businesses" if credit is only obtainable at credit-card-level interest? Or, will there just be the already-established big chains-- plenty of Wal-marts, but no independents?
These are the sorts of unintended consequences that come from the President of the United States publicly insulting and back-alley-threatening people who "holdout" hope that he will keep just over one-third of the promise he made to enforce contracts.
Goodbye Democracy, hello Oligarchy -- rule by the privileged few. Hope you're already friends with the few. 'Cause "he's" gonna make you an offa you cannot refuse, and if you do refuse, he cannot be held responsible for the actions of his associates....
Wikipedia: First Lien
Wikipedia: Senior Debt
Wikipedia: Unsecured Debt
Chrysler Ultimatum and the holdouts