Why President Obama was wrong for scolding hedge funds over Chrysler
Cliff Aness, who runs AQR Capital, has distributed an opinion letter discussing why President Obama was wrong for scolding hedge funds over their handling of Chrysler. I think this letter does a great job of explaining in simple terms why what the President did was wrong and that hedge funds are not in any way being greedy as the President has accused them.
Unafraid In Greenwich Connecticut
Clifford S. Asness
Managing and Founding Principal
AQR Capital Management, LLC
The President has just harshly castigated hedge fund managers for being unwilling to take his administration’s bid for their Chrysler bonds. He called them “speculators” who were “refusing to sacrifice like everyone else” and who wanted “to hold out for the prospect of an unjustified taxpayer-funded bailout.”
The responses of hedge fund managers have been, appropriately, outrage, but generally have been anonymous for fear of going on the record against a powerful President (an exception, though still in the form of a “group letter”, was the superb note from “The Committee of Chrysler Non-TARP Lenders” some of the points of which I echo here, and a relatively few firms, like Oppenheimer, that have publicly defended themselves). Furthermore, one by one the managers and banks are said to be caving to the President’s wishes out of justifiable fear.
I run an approximately twenty billion dollar money management firm that offers hedge funds as well as public mutual funds and unhedged traditional investments. My company is not involved in the Chrysler situation, but I am still aghast at the President’s comments (of course these are my own views not those of my company). Furthermore, for some reason I was not born with the common sense to keep it to myself, though my title should more accurately be called “Not Afraid Enough” as I am indeed fearful writing this… It’s really a bad idea to speak out. Angering the President is a mistake and, my views will annoy half my clients. I hope my clients will understand that I’m entitled to my voice and to speak it loudly, just as they are in this great country. I hope they will also like that I do not think I have the right to intentionally “sacrifice” their money without their permission.
Here’s a shock. When hedge funds, pension funds, mutual funds, and individuals, including very sweet grandmothers, lend their money they expect to get it back. However, they know, or should know, they take the risk of not being paid back. But if such a bad event happens it usually does not result in a complete loss. A firm in bankruptcy still has assets. It’s not always a pretty process. Bankruptcy court is about figuring out how to most fairly divvy up the remaining assets based on who is owed what and whose contracts come first. The process already has built-in partial protections for employees and pensions, and can set lenders’ contracts aside in order to help the company survive, all of which are the rules of the game lenders know before they lend. But, without this recovery process nobody would lend to risky borrowers. Essentially, lenders accept less than shareholders (means bonds return less than stocks) in good times only because they get more than shareholders in bad times.
The above is how it works in America, or how it’s supposed to work. The President and his team sought to avoid having Chrysler go through this process, proposing their own plan for re-organizing the company and partially paying off Chrysler’s creditors. Some bond holders thought this plan unfair. Specifically, they thought it unfairly favored the United Auto Workers, and unfairly paid bondholders less than they would get in bankruptcy court. So, they said no to the plan and decided, as is their right, to take their chances in the bankruptcy process. But, as his quotes above show, the President thought they were being unpatriotic or worse.
Let’s be clear, it is the job and obligation of all investment managers, including hedge fund managers, to get their clients the most return they can. They are allowed to be charitable with their own money, and many are spectacularly so, but if they give away their clients’ money to share in the “sacrifice”, they are stealing. Clients of hedge funds include, among others, pension funds of all kinds of workers, unionized and not. The managers have a fiduciary obligation to look after their clients’ money as best they can, not to support the President, nor to oppose him, nor otherwise advance their personal political views. That’s how the system works. If you hired an investment professional and he could preserve more of your money in a financial disaster, but instead he decided to spend it on the UAW so you could “share in the sacrifice”, you would not be happy.
Let’s quickly review a few side issues.
The President’s attempted diktat takes money from bondholders and gives it to a labor union that delivers money and votes for him. Why is he not calling on his party to “sacrifice” some campaign contributions, and votes, for the greater good? Shaking down lenders for the benefit of political donors is recycled corruption and abuse of power.
Let’s also mention only in passing the irony of this same President begging hedge funds to borrow more to purchase other troubled securities. That he expects them to do so when he has already shown what happens if they ask for their money to be repaid fairly would be amusing if not so dangerous. That hedge funds might not participate in these programs because of fear of getting sucked into some toxic demagoguery that ends in arbitrary punishment for trying to work with the Treasury is distressing. Some useful programs, like those designed to help finance consumer loans, won’t work because of this irresponsible hectoring.
Last but not least, the President screaming that the hedge funds are looking for an unjustified taxpayer-funded bailout is the big lie writ large. Find me a hedge fund that has been bailed out. Find me a hedge fund, even a failed one, that has asked for one. In fact, it was only because hedge funds have not taken government funds that they could stand up to this bullying. The TARP recipients had no choice but to go along. The hedge funds were singled out only because
they are unpopular, not because they behaved any differently from any other ethical manager of other people’s money. The President’s comments here are backwards and libelous. Yet, somehow I don’t think the hedge funds will be following ACORN’s lead and trucking in a bunch of paid professional protestors soon. Hedge funds really need a community organizer.
This is America. We have a free enterprise system that has worked spectacularly for us for two hundred plus years. When it fails it fixes itself. Most importantly, it is not an owned lackey of the oval office to be scolded for disobedience by the President.
I am ready for my “personalized” tax rate now.
“We have a free enterprise system that has worked spectacularly for us for two hundred plus years.”
The problem with this statement is you haven’t mentioned that part of our ‘free’ enterprise system includes the bankruptcy process. Yes, companies have assets, but one of the purposes of the bankruptcy is process is to protect those assets from creditors so the business can maintain operations. Of course, this is under the assumption saving the company from liquidation will have a net benefit for the economy (which some may argue against in Chrysler’s case).
So, let’s be clear. America does not have a FREE enterprise system, we have a ‘free*’ system.
*Note: free will be in play unless a companies failure will have dramatic negative effects on the national economy, then it will be come ‘kind of free’.
Gee, let’s have a hedge fund manager tell us that hedge funds have nothing to do with anything bad. That’s a great place to go to educate ourselves on the dynamics of the hedge fund industry. Impartial at that!
James - I’d love to have the discussion, but it’s hard to have a debate on the above article when you fail to keep an open mind on anything that stands to benefit the “wealthy”.
Pick out one statement or idea from Clifford’s letter and tell me why you disagree with him. I want to know why you think what Obama did was ok.
Brad,
I am not against the wealthy. I cannot support more the hard work of the successful, the long nights and weekends of business meetings, the ingenuity of entrepreneurs, and the creativity and leadership of management teams. In fact, especially considering the reasonable cost of living in Ohio that you know of personally, many would say the combined incomes and equity of my wife and myself would make us indeed “wealthy.” So, do not mistake me as an undermotivated, over-entitled twenty-something lashing out against society.
I am not a democrat. I am not a hippie. I do not support many Obama initiatives. I am against big government. But likewise I favor effective legislation to guide our country to justice and prosperity. And I indeed enjoy and appreciate many Rush Limbaugh points of view. I especially like Neil Bortz. What I am against, however, are the hypocracy and excesses of the “decision makers” in this country, in both government and the private sector alike.
The divide between the ubber wealthy and the middle class has been increasing at an unbelievably rapid pace over the past decade or two. The purchasing power of the middle class has actually fallen mostly to do with foreign competition. There is nothing wrong with this, for this is the way globalization works. What I do not like is that these executives profit from these decisions because it decreases their bottom line. You can see why the divide continues - the decision makers are rewarded at the expense of other citizens. Or as with the airlines when a company went bankrupt, unlike all other employees, upper management’s pension/severence was protected and they did not take a pay cut. It is this inequality of treatment which concerns me.
Eventually at this pace we will have a shell of an economy, where decision makers in the U.S. will be controlling companies whose workers are all overseas, with massive unemployment domestically. Or, if you believe in Keynesian Theory which in my opinion is more likely, U.S. employees will continue to lose wage to inflation as jobs become more scarce as they are outsourced and thus must lower their expectation to simply have employment. It has already been happening. This will continue to occur, justly so, but I am adamantly against executives profiting from such inevitability. Over time, as the divide continues, this would bring civil strife that we only read about in history books.
I am not against the “wealthy.” I am against the system which has allowed executives to profit at the expense of other U.S. citizens, and even the citizens of the rest of the world. Think hedge funds and oil price manipulation. Think CEO’s as directors of the board appointing their buddies to the board who then vote on executive compensation. Think the corruption, bribes, and politics of mutual fund managers voting shares of 401(k) equity for special interest. I am against the continual abuses of power that our executives have found as legal in our current code of law that they use to exploit other individuals at their profit.
I think I should start with the reminder that I can sit in a garage all day long - but that won’t make me a car. Mr. Asness’ piece to me demonstrates a combination of a straw-man argument mixed with a little bit of plain old mis-information. He does a lovely job however of presenting his views with a sense of default credibility that a simple critical read and an understanding of the Chrysler situation would easily dispel.
Point #1 - These were negotiations to keep Chrysler out of bankruptcy. That being the case, it should be understood that payments, loan guarantees, and any other monetizable elements on the company’s books (including Union benefits) were being put on the table for negotiation - negotiations that by definition would bring into question the value of assets and the level at which creditors would agree to receive payments for debt. There are 2 basic categories of debts in this equation - secured and unsecured. The secured debts are debts that map to assets that can be liquidated in the event of a default to pay a pre-arranged return (think car notes or mortgages). The unsecured debts do not map to assets and defaults trigger fees and penalties (think credit cards). When you get a credit card, the issuer has presumably investigated your finances and considers you a credit-worthy risk, but what happens when you default? Well aside from the fees and penalties you rack up, the account goes into collection. Collection agencies take the account off the books of the issuers - AT SOME DISCOUNT ON THE DOLLAR - and the collection of this debt becomes their responsibility. So, were the hedge fund hold outs all secured debt management groups? No. This means that in bankruptcy (think defaulting on the credit card) unless Chrysler’s assets could account for all the payments to the secured debt creditors and have enough left to pay the unsecured debt creditors (which they wouldn’t have), these hedge funds would be forced to take a discount on the dollar for their debt. The negotiations were an attempt at saving Chrysler from bankruptcy while pre-arranging those debt repayment terms.
Point #2 - Granted that the money managers have a fiduciary responsibility to effectively manage the money with which they are entrusted - just as credit card companies pull an individual’s financials and deem them credit-worthy or not (and they loose when they are wrong), so too it is also the fiduciary responsibility of these money managers to determine the credit-worthiness of the companies in which they invest.
Point #3 - The piece is wildly off-base in its attempt to try to paint these negotiations with the President stepping in as Robin Hood to take money from bond holders and give it to Unions.
It’s important to note that a few (not all) of the financial interests were the hold-outs in these negotiations - not Labor. Both the UAW and the CAW announced concessions that eliminated Christmas bonuses, third-shift at certain plants, reduced healthcare benefits, and cuts in retiree benefits. Labor and some of the financial interests were definitely not the hold-outs.
Point #4 - The notion that the President was lying when he indicated that some of these financial interests were holding out for a bail-out is itself a lie.
Asness presents this argument as if the hedge funds were leveraging for their own bailout, which is admittedly ridiculous - so why is it disingenuous to say that they weren’t holding out for a bailout? It’s because they were hoping, as the media had speculated for days, that the government would provide Chrysler with another bailout. The President was simply speculating that these financial interests were trying to call a bluff and waiting for the government to infuse the company with more money - something the administration was not prepared to do…it was a game of chicken that the hedge fund hold-outs lost.
Several of hold-outs held secured debt that certainly deserved more value than the unsecured debt held by the UAW.
The point I want to stress is that the President does not have the right to force creditors (through populist media tactics) to take less on their debt than what they feel they can get through bankruptcy. It is the sole decision of each creditor to decide if they want to accept a deal and if not all of them take it - than the company goes bankrupt. That is how bankruptcy works in America and these are the rules the creditors understood when they chose to fund the debt initially.
Creditors make decisions every day that drive companies into bankruptcy because they feel it is in their financial best interest. They are 100% entitled to this and they do not owe any favors to the US government or the people of this nation.
Admittingly the Asness piece above is not my favorite on the topic because he doesn’t stick to the point and instead he chose to take a political stab at Obama, but I chose to post it to the blog because I find it a more interesting read than some of the other stuff released by those opposed to what Obama did.
Have a look at this press release from a secured debt holder:
STAIRWAY CAPITAL MANAGEMENT L.P.
Official Press Release – 9:45am EDT – May 8, 2009
Subject - Chrysler
Stairway Capital Management (“Stairway”) has decided, after countless discussions with its investors, to actively withdraw from the Chrysler bankruptcy process.
We withdraw with the knowledge that we acted in good faith. We have fought for what we believe should be fair and equitable treatment under contract and bankruptcy law - in accordance with what traditionally occurs in a restructuring process. We remain steadfast in our view that there should be significantly more value attained, given a normal course bankruptcy negotiation. The fact simply is, however, our group has become too small to have a voice within the bankruptcy.
As American taxpayers, we appreciate the unprecedented efforts taken by the current Administration to stabilize the economy and the auto sector; but as fiduciaries to our investors we take exception to being compelled, as Chrysler senior secured lenders, to unfairly shoulder the burden relative to various junior creditors.
Finally, we would like to clarify some speculation about Stairway. We are not engaged in the business of underwriting or holding derivative contracts; we do not employ leverage in connection with our investments; and we have never been involved in the subprime mortgage market, at any level or context. Rather, Stairway is just a small private equity firm specializing in special situations and distressed debt opportunities.