The Chrysler bankruptcy: destroying more than it saves

Richard Epstein makes some excellent points against letting the government's vastly distorting "deal" for Chrysler's bankruptcy go through:

The proposed bankruptcy reorganization of the now defunct Chrysler Corp. is the culmination of serious policy missteps by the Bush and Obama administrations. To be sure, the long overdue Chrysler bankruptcy is a welcomed turn of events. But the heavy-handed meddling of the Obama administration that forced secured creditors to the brink is not.

A sound bankruptcy proceeding should do two things: productively redeploy the assets of the bankrupt firm and correctly prioritize various claims against the bankrupt entity. The Chrysler bankruptcy fails on both counts.

As I've said in several other posts, business risks are priced into the business model. Government sticking its nose into existing contractual arrangements distorts the risks in ways that none of the contracting parties could have foreseen. Had they been able to foresee the intervention, they would almost certainly not have entered into the contract or would have negotiated radically different terms to compensate for the greater risks.

The US government, by throwing aside the normal hierarchy of creditors, has damaged all future bankruptcies, by introducing greater uncertainty into what had been (by most accounts) a very successful and risk-contained process.

On claim priority, unsecured creditors come at the bottom of the bankruptcy totem pole. The basic rule of credit transactions distributes the net assets first to secured creditors in the order of their priority. First mortgages are normally paid in full before second, and lower mortgagees receive anything, in order, on their loans. Unsecured creditors of all types have an equal claim regardless of the time they perfected their claims. But they receive their first dime only after secured creditors have been paid in full.

It is absolutely critical to follow these priority rules inside bankruptcy in order to allow creditors to price risk outside of bankruptcy. Upsetting this fixed hierarchy among creditors is just an illegal taking of property from one group of creditors for the benefit of another, which should be struck down on both statutory and constitutional grounds.

In trying to pander to a politically favoured group, the US government has made every other potential bankruptcy that much more risky . . . and containing risk is critical to a properly functioning economy. Nice work, guys. Bomb-throwing anarchists nod in respect for the damage you've inflicted.