While everyone has been paying attention to the drama surrounding the smaller hedge funds that opposed the Obama administration’s plan for Chrysler, arguably the dynamics that led the largest lenders to Chrysler to acquiesce are far more important.
Why did Citigroup, Morgan Stanley, Goldman Sachs, and JPMorgan Chase all approve the offer from Washington that gave them 29 cents on the dollar, while the smaller firms held out?
A quiet consensus agrees that bank compliance was assured by the Troubled Asset Relief Program and the stress tests. The banks now operate under close supervision of the government. Those that need more capital must stay in the good graces of the government. Those that want to withdraw from TARP and pay back the funds must obtain the government’s approval, which is apparently completely discretionary and subject to no checks-and-balances. In short, these banks had no other option but compliance.
Or, rather, they did have an option that they chose not to take. Indeed, part of what has happened appears to be a result of what economists call “agency costs.” The management of the banks no doubt recognised that the bank regulators could order them removed if they resisted government plans, a threat reportedly made by Hank Paulson against Bank of America’s Ken Lewis when he balked at buying the loss-striken Merrill Lynch. Does anyone seriously doubt, for instance, that Citigroup CEO Vikram Pandit knows his job depends on staying in the good graces of the Obama administration? A wrong move and he could end up as the next Martin Sullivan. Even short of losing their jobs, the bankers know their ability to pay themselves is dependent on government approval. And even worse than joblessness or low compensation numbers could await anyone who crossed the administration. They could be the next Hank Greenberg. So, instead of attempting to get the best deal for their shareholders, the bankers chose the government’s plan and preserved their offices.
Politicized lending has always been said to be a theoretical danger of government investment in banks. But the speed with which political control has really taken hold is nothing short of breathtaking. At the very first crisis, we’ve seen banking decisions controlled by government. And the success of the government in the Chrysler case means that this is not the end point of politicized finance, it is just the beginning. We should expect Chrysler to serve as a model for a new kind of public-private partnership going forward.
The system worked pretty well when executives were charged with maximizing value for their shareholders. Under present circumstances, this would have meant bankers daring Obama to let Chrysler slide into bankruptcy without an agreement from most creditors. The path would have been ruinous for Chrysler. There’s no way that a Democratic president would ever have taken that path, and the banks knew this. They would have held out for the bailout of Chrysler to be divided in would have delivered something closer to the 50 cents on the dollar that the opposition firms were demanding.
This isn’t how a free-market works, of course. The banks would have been exploiting the vulnerability of a political party beholden to union interests. Indeed, there are some who think this is exactly what the hedge funds who continue to oppose the administration’s Chrysler’s plans are attempting to do. Free market purists reasonably object to this situation. But at least the core principle of maximizing shareholder value would have been conserved. Instead, we’ve replaced the profit motive with something else, an economically untethered political judgment about the willingness to make sacrifices for the common good.
The worst fears of how bailouts of banks would warp the markets were realised in the battle over Chrysler. And this particular horror flick is just getting started.
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