Monday, October 26, 2009

Indiana Pension Fund – Chrysler Bankruptcy Fiasco

I wouldn't write this story if there wasn't a story that needed telling. One thing bothered me about the Indiana Pension Fund – Chrysler bankruptcy fiasco is: What really happened? The “rumor” spreading around the Internet and seriously believed by some people I talked to in Indiana in May and June 2009 was that “Obama screwed the Indiana Pension Funds” by speeding up the bankruptcy and forcing Chrysler's sale to Fiat. When someone tells me that the United States President deliberately screwed a specific group of people, my skepticism gauge pegs to the red-alarm side, especially when the president is liberal leaning, which usually means “for people,” i.e., pension funds, verses “for corporations.” There must be more to this story than ideologue-rumor mongering that is intended to turn pension fund employees against a president. No Democrat president would want that.

The best place to start is to identify the players. On the pension funds' side is Indiana State Treasurer, Richard Mourdock, a geologist and Republican elected in 2006, and Indiana Governor Mitch Daniels, also a Republican in his second term. Governor Daniels is noted for his staunch anti-union policies. In his first term in 2005, he issued an executive order that rescinded collective bargaining rights of 23,000 state employees. I noticed in a number of Indiana newspapers that both were frequently making the best of the Chrysler bankruptcy for their own publicity ratings. The three funds Mr. Mourdock represented were the Teachers' Retirement Fund, an $8.6 billion fund, the Police Officers' Retirement Fund valued at $3.1 billion and the Indiana Major Moves Construction Fund (for roads and bridge construction). The values come from audited state financial statements for fiscal year ending June 30, 2008 available at Indiana's web site. I could not find a financial statement for the Major Moves Construction Fund. According to a statement Mr. Mourdock made in his 2006 campaign, the fund has about $500 million in it.

On the corporate side is Chrysler LLC (Limited Liability Company) and private equity firm Cerberus Capital Management that owned and managed Chrysler. Investment bankers included JP Morgan, CitiGroup, Goldman Sachs Group and Morgan Stanley who bought Chrysler's debt in the form of Corporate Bonds.

Labor unions included UAW, International Union, Aerospace Workers, Asbestos Workers and others. The UAW had 6,000 member workers in Indiana alone and 54,000 total members in Chrysler plants. And then there were ad hoc committees representing a gaggle of creditors from hedge funds, private equity companies, car dealerships to individuals injured in Chrysler automobiles.

The U. S. Treasury represented the U. S. Government and the tax payers who loaned $2 billion to Chrysler to pay off its creditors and to help bring the company back to some level of viability that, in the end, the loan failed to do. The $2 billion represented 28.99% of Chrysler's total $6.9 billion debt, or 29¢ on the dollar.

Chrysler's road to bankruptcy isn't about the Great Recession of 2008. The recession just hurried it along. Chrysler started on that road long before. Chrysler's story is the same as Simmons Bedding Company's story that was told in the New York Times recently and the last straw that broke Chrysler's back happened when Cerberus Capital Management bought Chrysler from the German Auto Maker, Daimler, the maker of Mercedes Benz. Daimler's purchase of American Motors and 1998 merger was both courageous and bullheaded. It turned out that neither of the companies could get along and Chrysler's shareholders sued Daimler for fraud, alleging that Daimler mislead shareholders. But, Chrysler never made a competitive car and it was losing money like a sieve and Daimler was eager to get rid of it. Daimler sold Chrysler for a loss and that's what private equity firms are looking for; cheap companies that can be flipped for debt and new buyers. Cerberus Capital Management never intended to make Chrysler a profitable company. Its only intention was to make a profit at the expense of investors and employees.

And that's what Cerberus Capital did. It borrowed $6.9 billion dollars using Chrysler's assets as collateral. By the time of the bankruptcy, Chrysler's tangible assets were valued at $800 million, from what I can tell, an 8.6 to 1 debt ratio, even though court documents stated that Chrysler had assets of about $39.3 billion and liabilities of $55.2 billion; still a hefty $1.4 to 1 ratio and more than Chrysler could afford. Only tangible assets, things you can touch and use can be auctioned in a bankruptcy. In a normal bankruptcy Chrysler would have paid creditors 11¢ on the dollar. So, how did Cerberus Capital borrow so much on so few assets​? In the first place it inflated Chrysler's asset values. According to Mourdock's congressional testimony [pdf], the total assets Chrysler (and Cerberus) claimed in 2005 before the recession were valued at $29 billion, but he testified that $3 billion of that was based on the imagined value of the Jeep brand name, assuming that the Jeep vehicle would continue to be sold and its popularity would continue into the future. So, $6.1 billion of the debt was based on intangible assets; things you cannot touch, feel, move, store, use or sell. The $29 billion was highly inflated. The inflated value, however, allowed Cerberus to sell the intangible debt to investment bankers and other investors in the form of corporation bonds and private shares, since Cerberus' new Chrysler was a private company and its shares were not sold on public exchanges. The sales pitch must have been very slick with lots of graphics, charts and numbers all showing a future profit. Cerberus paid itself fees for handling the purchase of Chrysler, packaging the debt into securities, i.e., bonds, and handling the sale of the debt. It also paid itself for managing Chrysler for the short period it owned it. So, Cerberus made a profit whether Chrysler went bankrupt or not.

I'm not able to find how much actual cash Cerberus received for the face valued $6.9 billion of bonds and stock, but there is a clue in the sale of the bonds that Mr. Mourdock bought from JP Morgan. Bonds are given a credit rating by Moodys and Standards & Poor from AAA, the highest rating, which usually pay the lowest interest and is the least risky, to Ca, that carry the most risk and earn the highest interest. Ratings AAA, AA, A and BBB are considered less risky, investor grade bonds and an investor can earn from 3% to 4% annually for AAA bonds to around 12%-13% for BBB bonds. Beyond BBB are the BB, B, CCC, CC, C, D and unrated bonds that enter the junk bond ratings. These pay enormous interest rates from 15% per year and higher and are the riskiest for not being paid at all in a bankruptcy. It is also usually true that the higher the interest rate, the shorter term for payoff. Ratings BB and lower usually indicate start up companies, companies with financial problems, such as Chrysler would have had when Cerberus bought it, and companies in highly competitive markets, which also could have included the automobile industry. Bonds rated C or D are worthless.

Mourdock paid $17 million to JP Morgan for $42 million in Chrysler Bonds on the secondary market, meaning that JP Morgan bought the bonds for less than $17 million and resold them to Mourdock on the aftermarket for a profit. Mourdock stated that the three funds he represented would lose a total $5.64 million if he accepted the Government's offer of 29¢ on the dollar of the total owed to the funds, $42 million. That meant that the funds would receive $12.2 million from the settlement and already had received $4.82 million in interest payments over a 20-month period. Depending on the term of the bonds, he was receiving between 18.2% to 23% annual interest on his investment. That's a very high interest rate and indicates that the bonds he purchased were high yield, speculative junk bond quality and very risky.

So, did President Obama screw the pension funds? It doesn't appear that way. It looks more like Mourdock got his just dues because he invested in risky bonds. Mourdock gave three reasons when trying to stop the bankruptcy sale of 20% stake in Chrysler to Fiat as ordered by the Southern Bankruptcy Court of New York. According to his congressional testimony (pdf), it was “the right thing to do” and “I pledged to uphold the Constitution of the United States.” His reasons for stopping the sale were: 1) the monetary loss to the funds, 2) the perceived violation of the law, and 3) general principals. Mourdock wanted Chrysler totally liquidated in bankruptcy and for the U. S. Treasury to pay Chrysler's loans in full, which meant that the U.S. Tax Payer would pay off his loan and Chrysler would cease to exist.

Since full payment from tax payers was out of the question, an irony I don't understand from a Republican who is against tax payer bail outs, Chrysler's liquidation was the only thing left to satisfy Mourdock. To send Chrysler into complete liquidation would have meant the loss of approximately 54,000 Chrysler jobs, 6,000 of which were in Indiana, and the sale of all of Chrysler's assets in auction to pay all of the creditors. Mourdock would then have received about 11¢ on the dollar instead of the 29¢ he received and he would have lost $13.2 million instead of $5.6 million. He argued that his loan had “seniority” over Chrysler employees and was, therefore, was a “secured” loan. The bankruptcy court gave seniority to the employees, similar to the seniority given to bank depositors over bank creditors in bank bankruptcies. Chrysler's sale to Fiat would guarantee that more employees kept their jobs and the UAW workers gave up $10 billion in future benefits to buy a 55% stake in the new Chrysler-Fiat company. This latter stake in the new company was what really “irked” Mourdock and other lenders objecting to the Fiat deal; they would not be stakeholders in the new company while the workers would be and this, they claimed, violated the “absolute priority” bankruptcy rule since they saw the workers as “junior creditors.”

Mourdock, therefore, claimed that President Obama's Administration violated the Constitution, Article I, Section 8, which says that the Congress will establish “uniform Laws on the subject of Bankruptcies throughout the United States.” The article means that bankruptcy law will be established at the national level by Congress and not by individual states. Bankruptcy has, for 200 years, offered relief for creditors unable to pay their debts and that's what Chrysler's bankruptcy did. The Northern Bankruptcy Court of New York appears to have followed the established law since the Supreme Court's review of the objections did not merit a Supreme Court hearing. The fact is that the U. S. Treasury participated in presenting a restructuring plan to the court, which included the sale to Fiat, and the court accepted it. There was nothing more to it than that.

The last of Mourdock's reasons was “general principals.” What can one say about principals except that they are likely ideological? The fact is that Mourdock would have lost more for the pension funds by winning his argument and that speaks badly for his sense of responsibility for his fiduciary duties. He's not supposed to lose money if he can prevent it, and if he can't avoid it – then he needs to make sure the loss is as small as possible. He would also have cost 54,000 UAW members their jobs, and that doesn't speak well for a politician who needs votes for reelection. It also doesn't speak well for his sense of compassion for the working person. So, his only argument must have been that he opposed the Obama Administration as an ideologue; pro-business, libertarian and anti-union, anti-government and anti-Obama. He jumped on the anti-Obama band wagon. His congressional testimony stated that President Obama called his complaint “unpatriotic,” “greedy speculators,” and “unwilling to sacrifice.” Obama didn't call him “unpatriotic.” But, Mr. Mourdock's purchase of the bonds was highly speculative and could be greedy. His management of the Teachers' Retirement Fund, for example, shows that he regularly buys “junk” rated, highly speculative bonds for the fund. Of the $3.58 billion invested in bonds for the fund, $922 million (26%) are invested in high yield, high risk bonds rated BB through Ca and unrated ($786mil). I'm sure that the Chrysler bonds are in the latter.

It seems to me that Indiana voters elected the wrong person for State Treasurer. Mr. Mourdock is a geologist, not an accountant, banker or financier who one would expect to be more suitable in an elected financial office. He also holds ideology above his fiduciary responsibilities, similar to the man he works for, Governor Mitch Daniels.

References: Toledo Blade, MSNBC, Fox Business News, Wall Street “Deal” Journal, Richard Mourdock's Web Site, Diamler-Chrysler Merger, OutsideTheBeltWay Blog, President Obama's Remarks and Bloomberg News.


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