Don't blame Chrysler's creditors

(breakingviews.com) -- It's politically expedient for President Obama to blame recalcitrant hedge funds and "speculators" for forcing Chrysler into bankruptcy. But they were right to just say no to the U.S. government's restructuring plan, which treads on the rights of senior creditors.

Caving in to Uncle Sam would have set a bad precedent for capitalism - and may ultimately hamper the president's exit strategy from Bailout America.

Technically it's true that a small group of investors, holding $1 billion of $6.9 billion of Chrysler's debt, played a pivotal role in deciding Chrysler's fate. By not accepting the 33 cents on the dollar they were being offered by Obama's automotive task force, the carmaker had no choice but to file for protection from its creditors.

But it's questionable whether Chrysler would have avoided bankruptcy even if the group had accepted the offer. Bankruptcy allows Chrysler to wrangle greater concessions from dealers, which notably eases Fiat's arrival, and ultimately makes Chrysler a stronger company. Solely blaming the hedge funds is disingenuous.

And even if Chrysler could have accomplished its aims without reverting to Chapter 11, the government's offer alone was reason enough for creditors to resist - and continue to press their case in the courts. Under the government's last proposal, the lenders would have received $2.25 billion in cash, implying a 67% haircut.

Despite being an unsecured creditor, however, the United Auto Workers is poised to retain half of Chrysler's $10.6 billion obligation to the union. That means the UAW gets 50 cents on the dollar even before accounting for the 55% stake in the new Chrysler-Fiat that it is receiving. Equity is obviously riskier than debt, but it's conceivable that the UAW will be made more than whole.

Politically speaking, this would be a great outcome for the president. But the message it sends to lenders is quite clear. Years of bankruptcy law have put secured creditors at the top of the pecking order, inducing them to put capital at risk. Vilifying investors who held firm to this conviction may have the reverse effect.