Socialism or Capitalism

The core of American business has been driven through a capitalistic society. Entrepreneurs raise money privately to create new companies. As these entities grow, the capital markets allow these businesses to raise additional funds from banks, the bond market, and the stock market. As companies prosper, so do the creditors and investors. When businesses falter, the creditors have protections written in the form of covenants on their debt and the priority given to them through security or other subordination language. This process has worked well for many years as small companies have grown into large global enterprises and poorly managed and over leveraged companies sometimes get reorganized through the bankruptcy process. Of course, these are the extremes but the United States is the leader of capitalism because this process is fair and not corrupted by government.

The world's financial system is in unprecedented times. Banks and other financial institutions have been weakened globally and their zeal to lend has been dramatically curtailed. The capital markets, although improving, is still not accommodating to many of the companies that easily accessed capital in the past few years. Unfortunately, many of these companies have increased their leverage during the peak years and are suffering during these weak economic times. We expect the bankruptcy rates to skyrocket this year and next and the reorganization of these entities will move the ownership from shareholders to creditors.

This brings us to the auto industry. We have been arguing for a restructuring of GM and Chrysler though prepackaged bankruptcies since November. These over bloated and over leveraged entities have needed to reorganize their cost structure and capitalization for a long time. Unfortunately, management was never willing to make hard decisions in euphoric economic times and are now being forced to right their ships during the worst economic time since the Great Depression. Banks and the capital markets did not provide new capital to GM and Chrysler so the government became the lender of last resort.

It is never a good idea to meld government finances with private enterprise. Just ask companies in Russia and Venezuela. Many banks took TARP money from the government to shore up their liquidity and it certainly seems like a curse as the Obama Administration lays out compensation conditions for employees of these companies. We can only anticipate what other requirements might be put forth to constrain corporate managers from running their businesses for the benefit of the shareholders. Many of these TARP banks are creditors of GM and Chrysler. Is the government pushing these financial institutions to make decisions in the restructuring process that is counter to the rights they process as secured lenders? It certainly appears that way when it comes to Chrysler.

The Obama administration is clearly orchestrating Chrysler's bankruptcy and has set the terms for a GM restructuring. Non TARP creditors in Chrysler are fighting back. They have a secured loan and expect to get better terms than unsecured lenders. The UAW and their health and pension plans are not secured. The rules of bankruptcy have not changed and the Obama government can not unilaterally change them. It certainly feels like a new Socialist Government is trying to abrogate the contractual rights of the lenders. If these methods of coercion persist, Capitalism in the United States could be harmed forever.

We warned that the government should have only made a loan to the auto companies in bankruptcy. They chose to do it their way and will likely lose some of the taxpayer money because they didn't do their homework. These restructurings are very complex and the creditors have rights. Just because Mr. Obama favors unions doesn't mean he can give them greater ownership of these companies than they deserve in bankruptcy. Furthermore, as long as the government loans to GM aren't breached, the Administration cannot unilaterally cram down the creditors.

Many of these actions are disconcerting. Investors have complicated analysis to make as shareholders or creditors. Thankfully, in the U.S. we don't have political risk to worry about. Or do we? The Obama Administration is clearly adding more risk to investing as its Socialistic principles are impeding our Capitalistic Society.