metadata: authors: 0: author: Anginer, Deniz
1: author: Warburton, A. Joseph
count: World
docna: 0: docna: The Chrysler effect : the impact of the
            Chrysler bailout on borrowing costs
docty: Policy Research Working Paper
subtopic: Social Policy,Legal Products,Labor & Employment Law,Judicial System Reform,Pensions & Retirement Systems,Social Funds and Pensions,Public Sector Economics,Capital Markets and Capital Flows,Financial Regulation & Supervision,Non Bank Financial Institutions,Capital Flows,Legal Reform,Financial Law,Legislation,Regulatory Regimes,Public Finance Decentralization and
            Poverty Reduction,Law Finance and Growth,Financial Sector Policy
teratopic: Private Sector Development,Finance and Financial Sector Development
abstracts: cdata!: Did the U.S. government's
            intervention in the Chrysler reorganization overturn
            bankruptcy law? Critics argue that the government-sponsored
            reorganization impermissibly elevated claims of the auto
            union over those of Chrysler's other creditors. If the
            critics are correct, businesses might suffer an increase in
            their cost of debt because creditors will perceive a new
            risk, that organized labor might leap-frog them in
            bankruptcy. This paper examines the financial market where
            this effect would be most detectible, the market for bonds
            of highly unionized companies. The authors find no evidence
            of a negative reaction to the Chrysler bailout by
            bondholders of unionized firms. They thus reject the notion
            that investors perceived a distortion of bankruptcy
            priorities. To the contrary, bondholders of unionized firms
            reacted positively to the Chrysler bailout. This evidence
            suggests that bondholders interpreted the Chrysler bailout
            as a signal that the government will stand behind unionized
            firms. The results are consistent with the notion that
            too-big-to-fail government policies generate moral hazard in
            the credit markets.
repnme: repnme: The Chrysler effect : the impact of the
            Chrysler bailout on borrowing costs
display_title: The Chrysler effect : the impact of
            the Chrysler bailout on borrowing costs
listing_relative_url: /research/2010/10/12927836/chrysler-effect-impact-chrysler-bailout-borrowing-costs
topicv3: Pension Funds m1326066 611,Insolvency and Debtor-Creditor Law
            m1326733 846,Treasury m1327009 1045,Collective Bargaining m1503879 2811,Retirement m1504007 2896
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: Private Sector Development,Finance and Financial Sector Development
no_of_pages: 48
model_extractions: WPS5462 Policy Research Working Paper 5462 The Chrysler Effect The Impact of the Chrysler Bailout on Borrowing Costs _Deniz Anginer A. Joseph Warburton_ The World Bank Development Research Group Finance and Private Sector Development Team October 2010
Policy Research Working Paper 5462

# **Abstract**

Did the U.S. government’s intervention in the Chrysler reorganization overturn bankruptcy law? Critics argue that the government-sponsored reorganization impermissibly elevated claims of the auto union over those of Chrysler’s other creditors. If the critics are correct, businesses might suffer an increase in their cost of debt because creditors will perceive a new risk, that organized labor might leap-frog them in bankruptcy. This paper examines the financial market where this effect would be most detectible, the market for bonds of highly unionized companies. The authors find no evidence of a negative reaction to the Chrysler bailout by bondholders of unionized firms. They thus reject the notion that investors perceived a distortion of bankruptcy priorities. To the contrary, bondholders of unionized firms reacted positively to the Chrysler bailout. This evidence suggests that bondholders interpreted the Chrysler bailout as a signal that the government will stand behind unionized firms. The results are consistent with the notion that toobig-to-fail government policies generate moral hazard in the credit markets.

This paper—a product of the Finance and Private Sector Development Team, Development Research Group—is part of a larger effort in the department to examine the role of the state in market development. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. The author may be contacted at danginer@worldbank.org.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
# **The Chrysler Effect: The Impact of the Chrysler Bailout on Borrowing Costs**<sup>*****</sup>

## **Deniz Anginer**

Economist The World Bank Washington, DC 20433 Email: danginer@worldbank.org

## **A. Joseph Warburton**

Assistant Professor of Law, College of Law Assistant Professor of Finance, Whitman School of Management Syracuse University Email: Warburto@syr.edu Keywords: Chrysler, bailout, bankruptcy, TARP, government regulation, cost of capital. JEL Classifications: G10, G14, G18, G31, G32, G33, G34, K2, K22, H5.

> * We thank Murillo Campello, Asli Demirguc-Kunt, and Nejat Seyhun for helpful comments and suggestions.  All errors are our own.

1
# **I. Introduction**

In late 2008 and early 2009, the outgoing Bush and incoming Obama administrations announced a series of steps to assist Chrysler, the struggling automaker, in an extraordinary intervention into private industry. Some charge that the government, in implementing the bailout, impermissibly favored the auto union over Chrysler’s secured bondholders. As these critics see it, the government attempted to save the politically powerful union by elevating the unsecured claims of organized labor above the secured claims of the bondholders, contrary to well-established creditor priorities in bankruptcy. If the critics are correct, the Chrysler bailout could represent an overturning of bankruptcy law in the U.S.

A long-standing principal of bankruptcy law requires that a debtor’s secured creditors be repaid, in full, before its unsecured creditors receive anything. However, critics argue that the government structured Chrysler’s bankruptcy reorganization so that Chrysler’s unsecured creditor, the auto union, got paid before Chrysler’s secured creditors were fully repaid. The auto union walked away from the reorganization with $1.5 billion in cash, a $4.6 billion note, and a majority equity stake in the reorganized Chrysler, despite the fact that Chrysler’s bondholders, who were secured creditors, had not been repaid in full. Although they had a $6.9 billion secured claim on Chrysler, the bondholders received only $2 billion in the reorganization, or twenty-nine cents on the dollar.

As critics view the Chrysler reorganization, the bankruptcy laws established by Congress were arbitrarily overthrown by an act of the Executive, undermining longestablished tenants of debt financing. They believe that, in protecting the interests of taxpayers, the Treasury negotiated aggressively with the secured creditors but, in protecting the interests of organized labor, the Treasury offered the union special treatment.<sup>1</sup> Hence, the critics attack the Chrysler reorganization as a government transfer

> 1 The Treasury negotiated aggressively in the reorganizations, extracting significant concessions.  Some felt that “the government was too tough, or too tough with the wrong parties.” CONG. OVERSIGHT PANEL, SEPTEMBER OVERSIGHT REPORT: THE USE OF TARP FUNDS IN THE SUPPORT AND REORGANIZATION OF THE DOMESTIC AUTOMOTIVE INDUSTRY 111 (2009) [hereinafter “PANEL REPORT”].  The negotiations reportedly gave rise to “allegations of threats and bullying.” PANEL REPORT, _supra_ , at n.506 (noting that the panel’s

2
of value from one group to another based on political considerations in place of established law. As one participant interpreted the transaction, the assets of retired Indiana policemen (which were invested in Chrysler’s secured debt) were given to retired Michigan autoworkers.<sup>2</sup> Critics wonder “why the UAW funds should be favored over other retirement funds, those that invested in Chrysler secured debt.”<sup>3</sup> Chrysler’s bondholders argued that the “government is penalizing people ... for having funded [their] retirement with ... bonds” and that they were “being ignored in negotiations and singled out to bear the greatest share of the cost of restructuring.”<sup>4</sup> Others believed that “everything this Treasury touches turns to politics.”<sup>5</sup> The Chrysler bondholders argued that the deal is “overturning the rule of law and practices that have governed our ... bankruptcy code for decades.”<sup>6</sup> Critics assert that this disregard of creditors’ rights represents a precedent-setting distortion of bankruptcy priorities, opening the door to future distributions of assets to favorite political groups.

Critics warn that the Chrysler reorganization will have severe consequences in financial markets, disrupting credit markets and increasing the cost of debt for borrowers. Financial experts such as Warren Buffett have stated that the federal government’s actions in the bankruptcy can have “a whole lot of consequences” for deal making.<sup>7</sup> According to Buffett, the government’s treatment of Chrysler’s secured creditors is “going to disrupt lending practices in the future. If we want to encourage lending in this country, we don’t want to say to somebody who lends and gets a secured position that the secured position doesn’t mean anything.”<sup>8</sup> Buffett’s concerns echo those of many debt market participants, who fear that “lenders may be unwilling to back unionized

> staff contacted many of the parties involved in the transactions to substantiate the allegations, but none of the inquiries received a response).

> 2 PANEL REPORT, _supra_ note 1, at 52.

> 3 Adler (2009) at 6.

> 4 Dennis Buckholtz, Op-Ed., _GM Bondholders Are People Like You and Me_ , WALL ST. J., May 27, 2009, at A17; _see_ also _Statement from Non-TARP Lenders of Chrysler_ , WALL ST. J., Apr. 30, 2009.

> 5 _Gettelfinger Motors_ , WALL ST. J., May 4, 2009, at A14.

> 6 _Statement from Non-TARP Lenders of Chrysler_ , WALL ST. J., Apr. 30, 2009.

> 7 Lou Whiteman, _Buffett Warns of Chrysler Cramdown Ramifications_ , THEDEAL.COM, May 5, 2009, _available at_ http://thedeal.com/dealscape/2009/05/buffett_warns_of_chrysler_cram.php. 8 _Id_ .

3
companies.”<sup>9</sup> Those participants believe “lenders will have to figure out how to price this risk .... [Either] don’t lend money to a company with big legacy liabilities, or demand a much higher rate of interest because you may be leap-frogged in a bankruptcy.”<sup>10</sup> A Congressional panel hypothesized that “Treasury’s involvement in the Chrysler bankruptcy ... is likely to cause investors to reevaluate their risk assessment regarding certain companies with similar characteristics.”<sup>11</sup> In other words, if a government bailout distorts creditor priorities, lenders may think twice before making secured loans to firms that might receive a government bailout, due to the risk that junior creditors might leapfrog them when the company experiences financial distress.

Critics distinguish public bailouts from other reorganizations because dealing with the U.S. government is not the same as dealing with private DIP lenders. The Treasury can exert greater influence over the parties than a private lender can. One reason is that “the government [can] accuse a bondholder ... of failing to assume some correct proportion of ‘shared sacrifice.’”<sup>12</sup> For example, President Obama referred to Chrysler’s dissident bondholders as “speculators” who were “refusing to sacrifice like everyone else.”<sup>13</sup> The U.S. government “has a throw weight that its counterparties cannot match, as there is little in the regular commercial arsenal that can counter a charge of ‘unpatriotic’ behavior by the President of the United States.”<sup>14</sup> Moreover, some critics fear that the Chrysler bailout is not an isolated, one-time event. Further government interventions using TARP funds have been suggested. For example, a Congressional panel, in its report on the use of TARP funds to support the auto industry, asked Treasury to “provide its legal analysis justifying the use of TARP funds for this purpose. This analysis will inform policymakers’ and taxpayers’ understanding of the potential for Treasury to use its authority to assist other struggling

> 9 Caroline Salas, _Fund Managers Burned by Obama Now Say They Are Wary_ , <u>http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a5u0MEwLik7A</u> (May 20, 2009, 18:13 EDT).

> 10 _Id_ .

> 11 PANEL REPORT, _supra_ note 1, at 53.

> 12 _Id_ . at n.506.

> 13 Press Release, Office of the White House Press Secretary, Remarks by the President on the Auto Industry (April 30, 2009), available at http://www.whitehouse.gov/the_press_office/Remarks-by-the-President-onthe-Auto-Industry.

> 14 PANEL REPORT, _supra_ note 1, at n.506.

4
industries.”<sup>15</sup> The panel’s report even lays out criteria for further Treasury interventions (in Section D). Hence, critics say the Chrysler bailout demonstrates the federal government’s inclination to intervene in private industry when politically motivated. Some market players assert that, with “anything that involves a large number of jobs or affects a large number of people, you can expect to see a Chrysler redux.”<sup>16</sup> Because of such possibilities, companies that are public bailout candidates may face higher borrowing costs than companies not at risk of government intervention.

Notwithstanding the criticisms, the Chrysler bailout does have its supporters. Supporters argue that the public assistance to Chrysler was a reluctant intervention by a lender of last resort acting through a clever but legal manipulation of the bankruptcy system. Supporters add that, in any event, the decision to assist Chrysler is an isolated policy choice that should have no ramifications beyond the auto industry. Others point out that priority violations in bankruptcy have become commonplace, especially with the development of the claims trading markets in recent decades, and should cause no alarm.

In other words, the Chrysler bailout has generated an important debate among market participants and academics in bankruptcy and finance. Did the government intervene in Chrysler in a manner that overturns bankruptcy law in the U.S.? This study answers that question by performing an empirical analysis of the bailout’s impact on credit markets.

The same question was raised by Congress when it established an oversight panel in connection with TARP to review “the impact of Treasury decisions on the financial markets.” The panel sought to examine “whether predictions that the Chrysler decision would result in changes in market behavior or the cost of capital were (1) accurate and (2) measurable.”<sup>17</sup> In its report to Congress, the panel concluded that “there is little evidence, empirical or anecdotal,” to answer the question. The panel believed that it is “too early and, given the number of variables, perhaps not possible to conclude one way or another as to what effect the government’s involvement in the Chrysler bankruptcy will have on the credit markets.”<sup>18</sup> We, however, disagree with the panel’s conclusion.

> 15 _Id_ . at 5.

> 16 Salas, _supra_ note 9.

> 17 PANEL REPORT, _supra_ note 1, at 53. 18 _Id_ .

5
This study performs the crucial empirical analysis of the government’s bailout of Chrysler that the oversight panel did not attempt.

We answer the question empirically by examining the financial market where the effect would be most detectible, the market for bonds of highly unionized companies. If the government, in order to favor organized labor, implemented the Chrysler reorganization in a manner that ignored established lending priorities, investors in other unionized companies should have perceived increased risk. Rational investors would price this increased risk into the debt of the unionized firms. We test this claim empirically and find no evidence of a negative reaction to the Chrysler bailout by the bondholders of unionized firms. We thus reject the notion that investors perceived a distortion of bankruptcy priorities in the Chrysler case.

To the contrary, we find that bondholders of unionized firms reacted positively to the Chrysler bailout. During the period when the Chrysler bailout was being formulated, adopted, and implemented, bonds of unionized firms generated lower yields (i.e., traded at higher prices in the bond markets) than bonds of non-unionized companies. Unionized firms also generated greater returns over the period for their bondholders than nonunionized firms generated for their bondholders. That is, it appears that bondholders interpreted the Chrysler bailout as a signal that the government will stand behind the obligations of unionized firms. In other words, the Chrysler bailout created a perception that unionized companies will receive preferential treatment from the government. This result suggests that the bailout generated moral hazard in the credit markets. Although the result is not dispositive of the issue, the paper provides empirical support for a link between “too-big-to-fail” government policies and moral hazard in the financial markets.

The next section describes the federal government’s bailout of Chrysler. Section III presents the hypotheses to be tested. Section IV identifies the related literature. Section V describes the data and the methodologies employed. The empirical results are presented in Section VI. Section VII concludes.

# **II. The Reorganization of Chrysler**

In December, 2008, Chrysler (along with General Motors) was on the brink of insolvency. The automaker could not obtain the financing needed to conduct day-to-day 6
operations. Chrysler, which employed over 55,000 workers, turned to the U.S. government for help. Congress considered legislation that would rescue the automaker, but the legislation failed to pass. President Bush thereupon ordered the United States Department of the Treasury (the “Treasury”) to extend a $4 billion loan to Chrysler. To make the loan, the Treasury tapped funds in the Troubled Asset Relief Program (“TARP”) enacted by Congress through the Emergency Economic Stabilization Act of 2008 (“EESA”)<sup>19</sup> as a way to keep distressed financial institutions from collapsing.

The $4 billion loan was only a bridge loan, however, intended to buy Chrysler a few extra months of breathing room until the incoming Obama administration entered office. The loan required that Chrysler submit to the Obama administration a turn-around plan showing Chrysler’s proposed path to becoming a viable, independent entity. On February 17, 2009, Chrysler submitted its proposed plan to the Obama administration. Notably, Chrysler’s plan contemplated the eventual full repayment of its outstanding senior secured debt.<sup>20</sup> On March 30, 2009, the Treasury rejected Chrysler’s plan, and gave Chrysler thirty days to propose another arrangement that would eliminate the company’s senior secured debt through the use of the bankruptcy code.<sup>21</sup> More particularly, the Treasury announced that Chrysler’s revised plan would have to show that Chrysler will take several steps: (i) enter into a partnership with Fiat to bring new management and technology to Chrysler; (ii) enter into a new collective bargaining agreement with the United Auto Workers union (the “UAW”); and (iii) restructure its balance sheet so that it has a sustainable debt burden. The Treasury contemplated that this third step would “require extinguishing the vast majority of Chrysler’s outstanding secured debt and all of its unsecured debt and equity.”<sup>22</sup> The Treasury stated that the “most effective way for Chrysler to emerge from this restructuring [would be to use] an expedited bankruptcy process as a tool to extinguish liabilities.”<sup>23</sup> Treasury told Chrysler's creditors that, instead of reorganizing under a Chapter 11 plan, Chrysler must opt for a “quick and

> 19 12 U.S.C. §§ 5201-5241.

> 20 Chrysler Restructuring Plan for Long-Term Viability (February 17, 2009).

> 21 Press Release, Office of the White House Press Sec‘y, Fact Sheet: Obama Administration New Path to Viability for GM & Chrysler (Mar. 30, 2009), _available at_ http://www.whitehouse.gov/assets/documents/Fact_Sheet_GM_Chrysler_FIN.pdf.

> 22 _Id._

> 23 _Id_ .

7
surgical” reorganization. The Treasury envisioned that Chrysler would sell its assets “free and clear” of all interests, under section 363 of the Bankruptcy Code, to a newly created shell corporation that would become the revitalized “Chrysler.”<sup>24</sup> Only if these conditions were satisfied would the Treasury provide the billions of dollars of additional TARP loans required to finance Chrysler's ongoing operations. Since the TARP-funded loans were the only apparent source of available cash, most of Chrysler’s creditors acquiesced to the proposed restructuring plan. A timeline of events is set forth in the Appendix hereto.

Here’s how the restructuring worked. Chrysler and its subsidiaries (referred to herein as “Old Chrysler”) filed for bankruptcy protection under Chapter 11 of the Bankruptcy Code on April 30, 2009.<sup>25</sup> Instead of then exiting Chapter 11 through a plan of reorganization confirmed by the creditors, the company left bankruptcy through the “side door” of section 363 of the Bankruptcy Code. Section 363 allows a debtor to sell assets to a buyer free and clear of creditor claims. Only weeks after filing for Chapter 11, the majority of Old Chrysler’s assets were sold to a newly-formed entity (referred to herein as “New Chrysler”) under section 363 of the Code.<sup>26</sup> New Chrysler agreed to assume some of the liabilities of Old Chrysler, most notably the unsecured obligations owed to UAW retirees. But most liabilities remained with Old Chrysler, including the secured liabilities owed to Old Chrysler’s lenders. Through this mechanism, critics argue, _the claims of unsecured creditors_ (the UAW retirees) _were elevated above the claims secured creditors_ , contrary to established priorities in bankruptcy.

To see this, consider the following. Upon filing Chapter 11, Old Chrysler was indebted to several groups of creditors. First, Old Chrysler owed $6.9 billion to a syndicate of lenders, secured by a first-priority security interest in substantially all of Old Chrysler’s assets.<sup>27</sup> Second, Old Chrysler owed $2 billion to Cerberus and Daimer, Old Chrysler’s equity holders, secured by a second-priority security interest in Old Chrysler’s

> 24 Pet.App. 120a-125a.

> 25 _See_ Voluntary Petition, _In re_ Chrysler LLC, 405 B.R. 84 (Bankr. S.D.N.Y. 2009) (No. 09-50002).

> 26 _See In re_ Chrysler LLC ( _Chrysler I_ ), 405 B.R. 84, 113 (Bankr. S.D.N.Y. 2009), _aff’d_ , 576 F.3d 108 (2d Cir. 2009), _vacated sub nom._ Ind. State Police Pension Trust v. Chrysler LLC, 130 S. Ct. 1015 (2009) (mem.).

> 27 _Chrysler I_ , 405 B.R. at 89.

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assets.<sup>28</sup> Third, Old Chrysler owed over $4 billion to the U.S. Treasury pursuant to TARP (and to the Canadian government), secured by a third-priority security interest in Old Chrysler’s assets.<sup>29</sup> Fourth, Old Chrysler owed $10 billion, on an unsecured basis, to a trust established to provide healthcare benefits to union retirees (the “UAW Trust”), a voluntary employee benefit association.<sup>30</sup> Unlike the other debt, the obligation to the UAW Trust was not secured. As an unsecured creditor, the UAW Trust was entitled to repayment only after Old Chrysler’s secured creditors has been repaid in full. Finally, Old Chrysler owed approximately $5 billion to various trade creditors, as well as billions in warranty and dealer obligations.<sup>31</sup> This indebtedness was also unsecured. Finally, Old Chrysler owed about $5 billion in debtor-in-possession financing to the U.S. Treasury and the Canadian government to fund Chrysler’s bankruptcy.<sup>32</sup> The crucial features of the Chrysler reorganization are illustrated in Figure 1. With the approval of the bankruptcy court, Old Chrysler sold substantially all its operating assets to New Chrysler, a newly-formed entity, in exchange for $2 billion in cash from New Chrysler and the assumption of some of Old Chrysler’s liabilities (most notably, the obligations owed to the UAW Trust). The $2 billion received by Old Chrysler was distributed to Old Chrysler’s first-priority secured lenders, in accordance

> 28 _Id_ .  Chrysler’s equity was owned by Cerberus Capital Management, L.P. and its affiliates (80%) and by Daimler AG and its affiliates (20%). _Id_ .

> 29 _Id._ at 89-90.  The government’s security interest had third priority in the assets encumbered by the firstand second-priority security interests, and a first-priority security interest in any remaining unencumbered assets.

30 Application for Immediate Stay of Sale Orders Issued by the Bankruptcy Court at 6, Ind. State Police Pension Trust v. Chrysler LLC, 129 S. Ct. 2275 (2009) (No. 08A1096).

Chrysler’s $10 billion commitment to the UAW Trust arose out of a litigation settlement reached in 2008 with the International Union, United Automobile Aerospace and Agricultural Implement Workers of America (the “UAW”). Pursuant to the settlement, Chrysler was obligated to fund the UAW Trust with cash. According to the Panel Report, By the end of the last century, Ford, Chrysler and GM found themselves faced with tens of billions of dollars in employee health obligations. In 2007 and 2008, after it became clear to both the companies and their unions that the state of the American automotive industry made these healthcare obligations unsustainable, the UAW and each of the three companies ultimately entered into an agreement whereby, in exchange for significant upfront payments principally in the form of cash and notes, healthcare obligations for retired union employees would be transferred off the books of the companies and into a trust (an independent entity totally separate from either the union or the automotive companies), the UAW Retiree Medical Benefits Trust, a Voluntary Employees’ Beneficiary Association. PANEL REPORT, _supra_ note 1, at n.49.

> 31 _Chrysler I_ , 405 B.R. at 89.

> 32 _Id._ at 92.  With a priming lien, the debtor-in-possession lenders would have been entitled to repayment ahead of the first-priority secured lenders.  However, the debtor-in-possession lenders were the U.S. Treasury and Canada, the sponsors of the restructuring.

9
with bankruptcy’s priority rule. Since the first-priority secured lenders were owed $6.9 billion, they received 29 cents on the dollar, leaving no assets for junior secured lenders or for unsecured creditors. Old Chrysler’s equity holders also received nothing.

How did New Chrysler, a newly formed entity, obtain the cash to purchase Old Chrysler’s assets? The U.S. Treasury agreed to provide New Chrysler up to $6 billion in senior secured loans to fund the asset purchase, as well as its ongoing operations.<sup>33</sup> The Canadian government, in addition, committed to provide financing to New Chrysler’s Canadian affiliate. In return, New Chrysler issued an 8% equity stake to the U.S. Treasury and a 2% equity stake to the Canadian government.<sup>34</sup> Up to 35% of the equity in New Chrysler was awarded to Fiat S.p.A. (“Fiat”) in return for its provision of technology, distribution systems, and other capabilities to New Chrysler.<sup>35</sup> As part of a collective bargaining agreement with the UAW, New Chrysler granted a 55% equity stake to the UAW Trust, paid $1.5 billion in cash to the UAW Trust, and issued a $4.6 billion unsecured note to the UAW Trust.<sup>36</sup> It was an important step for New Chrysler to reach the collective bargaining agreement with the UAW. Covering both active and retired workers, the agreement provides New Chrysler with Old Chrysler’s labor force but at a reduced wage structure for active employees and a reduced funding structure for retirees, bringing them more into line with those of foreign auto manufacturers in the U.S.<sup>37</sup> Such an agreement was obtainable, in part, because the UAW wanted to ensure continued employment for its active employees as well as continued funding of the UAW Trust for retirees. UAW retirees have to look exclusively to that UAW Trust for healthcare benefits, and Old Chrysler’s obligation to continue funding the UAW Trust is solely a contractual (i.e., voidable) one, not subject to ERISA funding rules.<sup>38</sup> The bankruptcy, consequently,

> 33 _Id._

> 34 New Chrysler also assumed $500 million of TARP financing owed by Old Chrysler to the U.S. Treasury and $600 million owed by Old Chrysler to the Canadian government.

> 35 Fiat has an initial 20% stake, which increases to up to 35% upon achievement of certain performance metrics.  The equity percentages presented above assume Fiat achieves those performance metrics. Initially, 9.85% of the equity in New Chrysler was held by the U.S. Treasury, 2.46% by the Canadian government, 67.69% by the UAW Trust, and 20% by Fiat. _Id._ at 92.

> 36 _Id._

> 37 PANEL REPORT, _supra_ note 1, at 18-19.

> 38 The UAW Retiree Medical Benefits Trust is a Voluntary Employees’ Beneficiary Association (VEBA). VEBAs are tax free entities that pay health, life, or similar benefits. Although subject to the fiduciary

10
jeopardized the funding commitments that Chrysler had made to the UAW Trust. In place of its $10 billion unsecured claim on Old Chrysler, the UAW Trust agreed to take a $4.6 billion unsecured note from New Chrysler, as well as $1.5 billion in upfront cash and a 55% equity stake in New Chrysler.<sup>39</sup> As a result, New Chrysler’s commitment to fund retiree healthcare benefits is not as burdensome as the one that weighted down its predecessor, while the UAW Trust walks away from the reorganization with a greater payout than it would have received had it remained solely an unsecured creditor of Old Chrysler.

During the bankruptcy proceedings, three Indiana state pension funds objected to Old Chrysler’s sale of its assets to New Chrysler and the release of their liens.<sup>40</sup> The Indiana pension funds were among the first-priority secured lenders of Old Chrysler.<sup>41</sup> The dissident pension funds argued that the sale would improperly result in value going to the unsecured creditors before the secured creditors had been paid in full.<sup>42</sup> Specifically, the pension funds pointed out that, according to the terms of the sale documents, an unsecured creditor of Old Chrysler, the UAW Trust, would receive payments (consisting of $1.5 billion in cash from New Chrysler, a 55% equity stake in New Chrysler, and a $4.6 billion note issued by New Chrysler) before Old Chrysler’s secured creditors had been paid in full.<sup>43</sup> The Indiana pension funds and the other first-priority secured lenders, receiving $2 billion from the sale on their $6.9 billion claim, would be receiving only twenty-nine cents on the dollar, while the UAW Trust, an unsecured lender, would be receiving payments worth billions of dollars.<sup>44</sup> The Indiana pension funds argued that the sale would violate creditor priorities, making it an illicit sub rosa confirmation plan.<sup>45</sup>

> requirements of the Employee Retirement Income Security Act of 1974 (ERISA), they are not subject to ERISA funding rules as are qualified retirement plans.  Instead, a company’s obligation to fund the trust is solely contractual.  PANEL REPORT, _supra_ note 1, at n.49.

> 39 Press Release, Office of the White House Press Sec‘y, Obama Administration Auto Restructuring Initiative (Apr. 30, 2009), _available at_ http://www.whitehouse.gov/the_press_office/ObamaAdministration-Auto-Restructuring-Initiative.

> 40 _Chrysler I_ , 405 B.R. at 93.  The funds consist of two pension funds that are fiduciaries for retirement assets of Indiana police officers and school teachers, and an infrastructure construction fund.  Petition for Writ of Certiorari at 4, Ind. State Police Pension Trust v. Chrysler LLC, 130 S. Ct. 1015 (2009) (No. 09285), 2009 WL 2864378.  The three funds together held about $43 million of first-priority secured debt of Chrysler. _Id._ There was more opposition earlier in the restructuring.  At one point, 30 funds holding over $1 billion objected to Obama’s plan.  Salas, _supra_ note 9.

> 41 _Chrysler I_ , 405 B.R. at 93.

> 42 _Id._ at 93.

> 43 _Id._ at 92.

> 44 _Id._ at 93.

> 45 _Chrysler I_ , 405 B.R. at 95-96.

11
The bankruptcy court, however, disagreed. Key to the court’s conclusion was its view that the UAW Trust would not be receiving any payments _on account of its pre-petition claims on Old Chrysler_ .<sup>46</sup> Instead, according to the court, the payments to the UAW Trust resulted from independent, arms-length negotiations between the UAW and the buyer (New Chrysler), resulting in the UAW Trust providing new value to New Chrysler. The bankruptcy court stated:

[I]n negotiating with those groups essential to is viability, New Chrysler made certain agreements and provided ownership interests in the new entity, which was neither a diversion of value from the Debtors’ assets nor an allocation of the proceeds from the sale of the Debtors’ assets. The allocation of ownership interests in the new enterprise is irrelevant to the estates’ economic interests.<sup>47</sup> The bankruptcy court viewed the payments to the UAW Trust as “provided under separatelynegotiated agreements with New Chrysler” and not on account of their pre-petition claims on Old Chrysler.<sup>48</sup> The Indiana state pension funds immediately appealed the bankruptcy court’s ruling. The Second Circuit issued a short order ratifying the bankruptcy court’s decision and issuing a stay to allow for the U.S. Supreme Court’s review. The Supreme Court, however, denied a request for a stay of the bankruptcy reorganization.<sup>49</sup> Upon remand, the Second Circuit affirmed the bankruptcy court’s decision.<sup>50</sup> The Second Circuit decided that all consideration paid to the UAW Trust by New Chrysler was in exchange for new value given, not in exchange for the UAW Trust’s claim on the debtor’s estate.<sup>51</sup> Hence, the court concluded that the transaction was consistent with bankruptcy priority rules and that the asset sale did not constitute a sub rosa confirmation plan.<sup>52</sup>

# **III. Hypotheses**

> 46 _Id._ at 99 (emphasis added).

> 47 _Id._

> 48 _Id._

> 49 Ind. State Police Pension Trust v. Chrysler LLC, 129 S. Ct. 2275, 2276 (2009) (per curiam).

> 50 _In re Chrysler LLC (Chrysler II), 576 F.3d 108, 119 (2d Cir.), vacated sub nom. Ind. State Police Pension Trust v. Chrysler LLC, 130 S. Ct. 1015 (2009) (mem.)._ On September 3, 2009, the Indiana pension funds filed a petition for writ of certiorari to the U.S. Supreme Court to appeal the Second Circuit’s decision.  Petition for Writ of Certiorari, _supra_ note 40.  The pension funds no longer sought to block the asset sale as before, but rather sought a greater repayment on the loan. _Id._ at 16-42. The Supreme Court, however, vacated the Second Circuit’s ruling and remanded the case to the Second Circuit with instructions to dismiss the appeal as moot.  Ind. State Police Pension Trust v. Chrysler LLC, 130 S. Ct. 1015 (2009) (mem.).

> 51 _Chrysler II_ at 118.

> 52 _Id._ at 118 n.9.

12
The Chrysler bailout was interpreted not only by the courts, but also by the credit markets. Did market participants believe the Chrysler bailout jeopardized lending priorities? The question may be answered empirically by examining the market where an effect would be most detectible, the market for bonds of highly unionized companies. Depending on how market participants viewed the government’s intervention in the Chrysler reorganization, the transaction could have produced a positive, a negative, or an insignificant impact on bond prices of unionized companies.

_H1: The federal government’s intervention in the Chrysler bankruptcy overturned creditor priorities under bankruptcy law, generating a fundamental change in how reorganizations will be conducted._ The first hypothesis is that the bond market interpreted the Chrysler bailout as an alteration of the long-standing absolute priority rule of bankruptcy. The absolute priority rule provides that claimants be paid in order of seniority, with secured creditors ranking ahead of unsecured creditors, who rank ahead of equity holders. A secured creditor, which lends to a debtor against collateral, expects to have a lower risk of non-payment than were it an unsecured creditor, and prices the loan accordingly. As a result, violations of established creditor priorities might have substantial ramifications for the availability and cost of credit.

If the market viewed the Chrysler bailout as a violation of creditor priorities, the bailout should have had a negative impact on bond prices of unionized companies. According to this hypothesis, investors in unionized companies should have demanded a higher return on their capital in response to the Chrysler bailout, to compensate for the increased risk that junior creditors (organized labor) might leap-frog them when the company experiences financial distress. In other words, bond prices of unionized companies should have significantly decreased following the Chrysler bailout. Stated equivalently, yields on bonds of unionized companies should have significantly increased.

Critics of the Chrysler reorganization argue that the transaction establishes a dangerous precedent by validating a deal structure that disregards creditor priorities in 13
bankruptcy.<sup>53</sup> The Bankruptcy Code requires that creditors receive “fair and equitable” treatment.<sup>54</sup> Fair and equitable treatment requires in part that a junior-priority class of claims may not receive assets from the debtor while a more senior class of claims has not been paid in full and objects to the payment.<sup>55</sup> In _Chrysler_ , certain secured creditors objected to the asset sale because they would only receive twenty-nine cents on the dollar while the UAW Trust, with a lower priority claim, would receive billions of dollars.<sup>56</sup> These secured creditors also attempted to invoke the rule against “unfair discrimination.”<sup>57</sup> The rule against unfair discrimination requires that similarly ranked creditors be paid pro rata.<sup>58</sup> Since the value of the secured creditors’ claims exceeded the value of Chrysler’s collateral, the secured creditors were deemed to be in part secured creditors (to the extent of the value of the collateral) and in part unsecured creditors (to the extent of their deficiency claim, the amount by which their secured claims exceed the value of the collateral).<sup>59</sup> Hence, with respect to their deficiency claim, the secured creditors were unsecured, ranking in priority equal to the UAW Trust and other unsecured creditors.<sup>60</sup> Yet the asset sale resulted in cash and securities being paid to the unsecured UAW Trust, while nothing was paid to the secured creditors on their deficiency claim.<sup>61</sup> The secured creditors argued that this result constitutes unfair discrimination.<sup>62</sup> These arguments were ultimately rejected in court.

As critics view the Chrysler reorganization, the bankruptcy law established by Congress were arbitrarily overthrown by an act of the Executive, undermining longestablished tenants of debt financing. The purported disregard of creditors’ rights in the Chrysler bailout would establish a precedent for future distributions of assets to favorite political groups.

> 53 _See_ Warburton (2010) for a more detailed delineation of arguments against the Chrysler reorganization. _See also_ Roe and Skeel (2010), Adler (2009), and Todd J. Zywicki, _Opinion, Chrysler and the Rule of Law_ , Wall St. J. (May 13, 2009).

> 54 11 U.S.C. § 1129(b)(1) (2006).

> 55 _Id._ § 1129(b)(2).  Known as the absolute priority rule, it, along with the requirement that no creditor be paid more than it is owed, constitute the fair and equitable rule.  7 COLLIER ON BANKRUPTCY ¶ 1129.03[4] (Allan N. Resnick & Henry J. Sommer eds., 16th ed. 2009).

> 56 _Chrysler II_ , 576 F.3d 118 (2d Cir. 2009).

> 57 Brief for Appellants Indiana State Pension Trust et al. at 24, _Chrysler II_ , 576 F.3d 108 (2d Cir. 2009)

> (No. 09-2311-bk), 2009 WL 1560029; _Chrysler II_ , 576 F.3d at 112-13.

> 58 7 COLLIER ON BANKRUPTCY, _supra_ note 55,  ¶ 1129.03[3].

> 59 Brief for Appellants Indiana State Pension Trust, _supra_ note 57, at 24; _Chrysler II_ , 576 F.3d at 123.

> 60 Brief for Appellants Indiana State Pension Trust, _supra_ note 57, at 24; _Chrysler II_ , 576 F.3d at 123.

> 61 Brief for Appellants Indiana State Pension Trust, _supra_ note 57, at 24; _Chrysler II_ , 576 F.3d at 123.

> 62 Brief for Appellants Indiana State Pension Trust, _supra_ note 57, at 24; _Chrysler II_ , 576 F.3d at 123.

14
Critics add that the Chrysler bailout is not an isolated, one-time event, as further government interventions using TARP funds have been suggested. Hence, lenders might believe the Chrysler bailout demonstrates the federal government’s inclination to intervene in private industry when politically motivated. As a result, lenders would be reluctant to make secured loans to firms that might receive a government bailout, or would demand a higher rate of interest, due to the risk that junior creditors might leapfrog them when the company experiences financial distress. If the bond market believes such possibilities are real, companies that are public bailout candidates should face higher borrowing costs than companies not at risk of government intervention.

_H2: The federal government’s involvement in the Chrysler bankruptcy occurred in accordance with the Bankruptcy Code, and no statutory priorities were overturned._ The second hypothesis is that the credit market believed the government was acting as an arm’s-length participant in a section 363 asset sale, which has become an increasingly common means to exit bankruptcy.<sup>63</sup> Proponents of the bailout argue that, although TARP money was used to fund the reorganization, the Treasury was nothing more than a debtor-in-possession (DIP) lender in an otherwise typical bankruptcy reorganization.<sup>64</sup> Although the involvement of the Treasury in place of a private lender may have been novel, the use of DIP financing and an asset sale to effect a reorganization was not. Hence, from this viewpoint, the transaction left unaltered established bankruptcy practices and priorities. Therefore, prices of bonds of unionized companies (and their yields) should not exhibit any significant change around the Chrysler bailout.

Proponents of the reorganization assert that no payments were made to the UAW Trust on account of the Trust’s pre-petition claims on Old Chrysler. Instead, they argue that the payments to the UAW Trust were extracted from New Chrysler, the newlyconstituted entity, as the product of a fresh negotiation between the Trust and New Chrysler.<sup>65</sup> While the proceeds that the debtor receives in an asset sale must be

> 63 _See_ Stephen J. Lubben, Appendix to Testimony Before Oversight Panel, (July 27, 2009).

> 64 _See_ Warburton (2010) for a more detailed delineation of the arguments in defense of the Chrysler reorganization. _See also_ Morrison (2009) and Lubben (2009).

> 65 Critics respond that the asset sale by Old Chrysler did more than merely sell assets for cash.  The sale effectively determined which creditors of the Old Chrysler would get paid, and how much they would be

15
distributed to its creditors in accordance with the Bankruptcy Code’s priority rule, the purchaser of assets is not restrained by the Code in its use of those assets, the price it pays to acquire them, or any other manner.<sup>66</sup> Proponents observe that the purchaser is free to strike any deal it can with its own financers, suppliers, labor unions, and other stakeholders. If these stakeholders establish relationships with the purchaser on more favorable terms than “those whose relationships terminated with the bankruptcy estate, this perceived disparity has a clear business reason; i.e., the purchaser needs to maintain these relationships to make its business viable.”<sup>67</sup> For instance, if the purchaser needs to continue ordering from the debtor’s suppliers, then those suppliers may be paid by the purchaser even though the suppliers are entitled to nothing from the debtor under Chapter 11. The two transactions are independent; there is no “exchange” of claims against the debtor for payments from the purchaser. This is the case so long as payments from the purchaser are made in exchange for the provision of goods or services to the purchaser. According to supporters of the Chrysler asset sale, the assets were purchased cleanly and appropriately from Old Chrysler by New Chrysler for $2 billion. New Chrysler then, in separate transactions, entered into independent agreements with financers, suppliers, labor, and other stakeholders, some of which happen to involve Old Chrysler’s creditors.

Proponents argue that New Chrysler had to negotiate with various constituencies “essential to the new venture, including . . . Chrysler’s employees – contributing a skilled workforce with a more competitive cost structure.”<sup>68</sup> Since New Chrysler needed skilled workers (and labor peace), proponents believe the UAW had bargaining leverage with New Chrysler, which enabled it to extract continued support for retiree health plans and an ownership stake in New Chrysler. The secured creditors of Old Chrysler lacked similar bargaining power with New Chrysler. Parties with whom New Chrysler must do business going forward (such as the UAW) have leverage in negotiating favorable terms, paid. Adler (2009) at 3; Roe and Skeel (2010) at 5 and 22. The sale terms fully determined the distribution amount that Old Chrysler’s secured creditors would receive from the debtor: the first-priority secured parties’ distribution equaled the $2 billion sales proceeds. Moreover, the sale terms provided Old Chrysler’s unsecured creditor, the UAW Trust, with $1.5 billion in cash, a promise of an additional $4.6 billion, and substantial equity in New Chrysler. The terms of the 363 sale, hence, fully determined the payments made to Old Chrysler’s creditors.

> 66 PANEL REPORT, _supra_ note 1, at 48.

> 67 _Id._

> 68 Chrysler I, 405 B.R. 84, 99 (Bankr. S.D.N.Y. 2009) _._

16
and nothing in bankruptcy law takes that leverage away. The UAW was able to negotiate directly with New Chrysler in the same way that any company can negotiate, without any restraints imposed by bankruptcy laws.

Moreover, proponents observe that the UAW made significant concessions to New Chrysler, including making substantial changes to its contracts in order to improve the profitability of New Chrysler. The secured creditors made no similar concessions. According to proponents, although the disgruntled secured creditors of Old Chrysler were disappointed with what they received in the bankruptcy, and felt that the UAW walked away with generous terms from New Chrysler, that outcome was the product of negotiations which are not within the scope of the bankruptcy laws.

In addition, supporters believe that it is not alarming, or even unusual, that the U.S. Treasury pushed for favorable treatment of certain stakeholders, the UAW retirees. The Treasury was the DIP lender, with the power and influence that role confers in any bankruptcy. As Chrysler’s condition deteriorated, the government provided both pre- and post-petition financing. On account of the government’s pre-petition claim, it had the rights of a pre-petition creditor entitled only to distributions from the bankruptcy estate in accordance with priority rules under Chapter 11. On account of its post-petition claim, however, the government had power and leverage as a DIP financer.<sup>69</sup> Because no postpetition lender is required to lend to the debtor and because dealing with bankrupt businesses is often regarded as quite risky, the leverage of the DIP lender is extremely high. As a result, DIP lenders routinely use the terms of the new loan to assume control and shape the outcome of the reorganization (for example, by deciding which contracts with suppliers, dealers, labor, etc. it wishes the debtor to assume).<sup>70</sup> At the time Chrysler filed bankruptcy, the capital markets were experiencing a credit freeze and the amount of money needed to reorganize the company was very large. This allowed any DIP financer that stepped forward even more leverage than it may have had under ordinary circumstances, according to supporters.<sup>71</sup>

> 69 To obtain financing to operate in Chapter 11, debtors arrange for debtor-in-possession (or DIP) financing.  Such financing is often provided by creditors who have existing loans with the debtor and hence act largely to limit their losses.

> 70 _See_ Lubben (2009) at 535; and  Miller and Waisman  (2004).

> 71 This argument also addresses claims of federal government bullying. _See supra_ note 1.

17
Because the Treasury played an important role in financing and negotiating the restructuring of Chrysler, proponents argue that it is not surprising that the Treasury exercised its bargaining power as a DIP lender to dictate that the UAW Trust receive special treatment. From this perspective, the Treasury was nothing more than a normal DIP lender. Although the involvement of the U.S. government in the reorganization may have been novel, proponents argue that the Treasury’s exercise of the DIP lender’s power in connection with the asset sale was not.<sup>72</sup> One “can debate whether it is wise for the government to bail out the UAW, but it does not implicate the bankruptcy process.”<sup>73</sup> It may also be argued that priority violations are common in bankruptcy and are already factored into bond prices. Research shows that priority violations in favor of junior investors over senior investors have been common.<sup>74</sup> Professors Baird and Bernstein explain, moreover, that these observed deviations from absolute priority do not necessarily flow from manipulation of Chapter 11 (Baird and Bernstein 2006). Rather, they more likely represent rational, voluntary settlements that reflect the uncertainty involved in valuing complex business enterprises in distress. Since Chapter 11 entitles junior investors to insist on an appraisal of the debtor, the outcome of which is uncertain, senior investors may willingly agree to distributions in favor of junior investors as an insurance policy against that uncertainty. That is, valuation uncertainty produces a bargaining dynamic that accounts for observed deviations from absolute priority, not a defect in Chapter 11 that allows junior investors to manipulate the process. Viewed in this light, the Chrysler reorganization does not represent a lack of commitment to the principle of absolute priority.

Moreover, some proponents argue that the Chrysler reorganization is a one-off transaction with no precedential value, due to the unusual circumstances surrounding it. The reorganization required heavy government involvement. Without the government flooding the businesses with cash, proponents believe the creditors might not have agreed to the terms of the reorganization. That is, any priority violation was accompanied by a large cash infusion from the government to help the company stay afloat. The downside to creditors of a priority violation was offset by the benefits of keeping the debtor in

> 72 Lubben (2009) at 546.

> 73 _Id._

> 74 _See_ text accompanying _infra_ note 78.

18
operation. Without that aspect, more creditors might have objected to the proposed terms, producing a more traditional and time-intensive reorganization process that may have ended in liquidation and a smaller net recovery by claimants.

Hence, from this perspective, the Chrysler restructuring does not disrupt existing bankruptcy laws or current bankruptcy practices. The government played fairly by the established rules. According to adherents of this view, the critics are bothered by the fact that the government was a major participant in the transaction, and that it chose to favor the union over investors. While critics may object to that decision, supporters say it is a policy question, not a legal one. If bond market participants view the Chrysler bailout in this manner, bond prices (and yields) of unionized companies should not exhibit any significant change around the bailout.

_H3: The federal government’s intervention in the Chrysler bankruptcy added moral hazard to the financial markets by issuing an implicit guarantee of the obligations of similar companies._ The third hypothesis is that, as a result of the government’s intervention in the Chrysler bankruptcy, lenders now expect future public interventions with respect to companies with similar characteristics, allowing them to avert bankruptcy. After the Lehman bankruptcy in September of 2008, there was tremendous uncertainty about potential federal government involvement in providing liquidity and short-term funding to large industrial firms. This uncertainty subsided with the federal government agreeing to provide support to the auto companies in December, 2008, essentially signaling to the markets that they would not allow large industrial firms subject to collective bargaining to fail. According to this view, the credit markets interpreted the auto bailout as meaning that the class of large industrial firms subject to collective bargaining is now “too big to fail.” The possibility of a government infusion of funds into “too-big-to-fail” companies could make those companies more attractive for bond investors by lowering their risk of nonpayment. If they interpret the Chrysler bailout in this manner, bond investors should reevaluate their risk assessments of large unionized companies with significant political importance, and demand a lower return on their capital to compensate for the lower perceived risk of such companies. Consequently, bond prices of unionized companies 19
should have significantly increased following the Chrysler bailout. Or, equivalently, bond yields of unionized companies should have significantly decreased.

We test these hypotheses empirically in this paper.

# **IV. Related Literature**

When it established the TARP, Congress created an oversight panel (the “Oversight Panel”) to oversee Treasury’s administration of the TARP. The Oversight Panel was mandated to review “the impact of Treasury decisions on the financial markets” and, regarding the decision to bail out Chrysler, to “determine whether predictions that the Chrysler decision would result in changes in market behavior or the cost of capital were (1) accurate and (2) measurable.”<sup>75</sup> However, after consulting with academics and market participants, the Oversight Panel concluded that “there is little evidence, empirical or anecdotal, to prove or disprove the claim that the Chrysler bankruptcy had any effect on the market.”<sup>76</sup> Few academic studies are on point, and the existing papers do not shed much light on the issues. There has been some empirical research on priority violations in bankruptcy (Franks and Torous 1989, 1994; Eberhart, Moore and Roenfeldt 1990; Weiss 1990<sup>77</sup> , Betker 1995, and Bharath et al. 2007). Studies find that priority violations in favor of equity holders were common in the 1980s, but since the mid-1990s equityfavoring violations have disappeared as a result of greater creditor control of bankruptcy. However, those studies focus on the subordination of creditors to equity holders, not the subordination of one (senior) creditor class to another (junior) creditor class, as this paper does.

Unlike those studies, which treat creditors as a single, unified class, this study examines conflict between senior and junior classes of creditors. That is, we focus on the purported subordination of secured creditors to unsecured, but politically-favored, creditors. This is an important line of inquiry. A secured creditor, which lends to a

> 75 PANEL REPORT, _supra_ note 1, at 53.

> 76 One of the academics consulted by the Oversight Panel stated, “I am unaware of empirical support for the claim that the Chrysler and General Motors cases will increase the cost of capital to corporate debtors.” Yet, the same academic believed that, given these cases, “one might expect future firms to face a higher cost of capital.” Adler (2009) at 6.

> 77 Weiss looks at the claims of secured creditors, unsecured creditors, and equity holders in bankruptcy from 1979 to 1986, but finds no violations of the secured creditors’ priority.

20
debtor against collateral, expects to have a lower risk of non-payment than were it an unsecured creditor, and prices the loan accordingly. As a result, violations of established creditor priorities might have substantial ramifications for the availability and cost of credit.

Recently, the law scholarship has turned its attention away from the conflict between creditors and equity holders, focusing instead on the conflict between senior and junior creditors. This interest in creditor conflict coincides with the development of the claim trading market for distressed securities. The law scholarship observes that claims trading has resulted in a traditional, fairly homogenous set of creditors being replaced by a more fluid set of stakeholders, including distressed debt investors with varying motivations and objectives (Baird and Rasmussen 2010, 2003; Ayotte and Morrison 2009; Baird 2009; Levitin 2009; Baird and Bernstein 2006; Miller and Waisman 2004). Law scholars debate whether the claims trading market is beneficial or harmful for the bankruptcy reorganization process and the cost of capital for business. But the literature is mostly theoretical and, as a result, “scholarly treatments have operated with a high level of generality and scant evidentiary basis.”<sup>78</sup> Law scholars have seized upon the Chrysler reorganization to continue this debate. While some argue that the Chrysler case “cannot be understood as complying with good bankruptcy practice...” and that it has “potential for disrupting financial markets surrounding troubled companies...” (Roe and Skeel 2010; see also Adler 2009), others see it as “entirely within the mainstream of chapter 11 practice” (Lubben 2009).<sup>79</sup> But again, the debate has proceeded with little empirical evidence. For instance, while Adler (2009) cautions that “one might expect future firms to face a higher cost of capital” as a result of Chrysler, he also states, “I am unaware of empirical support for the claim....” Hence, we contribute to this literature by providing needed empirical evidence.

Our paper also contributes to the literature tracing the effects of government bailouts on the firm (e.g., Jiang, Kim and Zhang 2010; and Faccio, Masulis, and McConnell 2006). Existing studies examine the impact of government bailouts on firm

> 78 Levitin (2009) at 67.

> 79 _See_ Warburton (2010) for a summary of arguments on each side of the debate.

21
performance. But we examine a different effect. Our study looks at the impact of bailouts on borrowing costs in the credit markets.

Our paper is also related to the empirical literature on moral hazard in financial institutions. While most of that literature examines how the too-big-to-fail status of a bank benefits its stockholders (e.g., Demirgüç-Kunt and Huizinga 2010; Fratianni and Marchionne 2010; Angbazo and Saunders 1997; Black et al. 1997; and O’Hara and Shaw 1990), there have been a few studies that examine the effects on bondholders (Morgan and Stiroh 2005; Penas and Unal 2004; and Flannery and Sorescu 1996). Our study furthers that literature on moral hazard in credit markets.

Academic research has looked at the role of organized labor within the firm, though it has not explored whether government bailouts of unionized firms impact credit markets. Previous research has shown that unionization has an impact on firm operations. For example, labor unions increase worker salaries<sup>80</sup> , reduce firm operating flexibility<sup>81</sup> , reduce firm profitability and equity values<sup>82</sup> , and impact corporate investment decisions.<sup>83</sup> Chen et al. (2010b) finds that firms in more unionized industries have lower bond yields than firms in lesser unionized industries. The authors of that study believe bondholders view unions favorably because they place a check on management, mitigating agency within the firm. But Chen et al. does not examine the role of public support for unionized companies, which is the focus of our paper. Moreover, Chen et al. studies the period 1984-98. In contrast, our paper focuses on the recent financial crisis and the government’s response. As such, we are able to examine whether government bailouts of unionized firms have an impact on bond prices.

# **V. Data & Methodologies**

In this section, we briefly describe the data sources used in this study. Firm-level accounting and price information are obtained from COMPUSTAT and CRSP. Bond trade prices are obtained from the Trade Reporting and Compliance Engine (TRACE)

> 80 _See_ , e.g., Lewis (1986).

> 81 _See_ , e.g., Chen, Kacperczyk, and Ortiz-Molina (2010a).

> 82 _See_ , e.g., Hirsch (1991) and Abowd (1989).

> 83

> _See_ , e.g., Connolly, Hirsch, and Hirschey (1986).

22
syste <mark>m dataset for</mark> the time period January 2008 to December 200 <mark>9.</mark><sup>84</sup> We follow Bessembinder et al. (2009) by eliminating cancelled, corrected, and commission trades from the data. We merge the remaining bond trades with the Fixed Income Security Database (FISD), which contains information regarding each bond’s rating, time to maturity, coupon payments, and other characteristics. Our sample includes all U.S. corporate bonds listed in <mark>FISD t</mark> hat satisfy a set of selection criteria commonly used in the corporate bond literature.<sup>85</sup> We remove all bonds with equity or derivative features (i.e., callable, puttable, and convertible bonds), bonds with warrants, bonds with floating interest rates, and bonds with any credit enhancements. We also eliminate all bonds that have less than one year to maturity or have been issued less than a year ago, and require all bonds to have an assigned rating and SIC code. As we are interested in industrial firms, we remove all financial firms from the sample (SIC codes 6000-6999). So as to not bias our analyses, we also remove from the sample Ford, General Motors and Chrysler. To be able compute daily bond returns, we also require bonds to have traded on two consecutive days over the sample period. Our final sample consists of 508 bonds from 269 firms. � Bond returns are calculated as: where _Pt_ is the clean price of the bond, _AIt_ is the accrued interest over one period, and _Ct_ is the coupon payment whenever it is paid (in which case _AIt_ = 0). To remove potential data entry errors, we follow Bessembinder et al. (2006) by requiring that the absolute value of the return be less than 30%. As there are multiple bonds for each firm, company-level returns are computed by value-weighting individual bond returns using their market values.

To identify firms subject to collective bargaining, we go through 10-K reports filed with the U.S. Securities and Exchange Commission by the 269 firms in our

> 84  TRACE reports prices for roughly 95% of all corporate bond transactions.  The only transaction that are not reported are those that take place in exchanges.

> 85 _See,_ for instance, Duffee (1999), Collin-Dufresne, Goldstein, and Martin (2001) and Avramov et al. (2006).

23
dataset.<sup>86</sup> We categorize companies as unionized or non-unionized. We define a unionized company as one where 30% or more of its workforce is unionized or covered by a collective bargaining agreement.<sup>87</sup> We are unable find unionization rates for all the firms in our sample. Of the 269 firms in our sample, we are able to find unionization rates for 163 firms. Of the 163 firms, we classify 69 as unionized.

Conceivably, there could be significant differences between unionized and nonunionized companies that might impact our results. Hence, we want to be sure that our results do not reflect differences between the two sets of firms, particularly regarding differences in credit risk. We compute summary statistics for various default measures and financial characteristics of unionized and non-unionized companies. These are the same measures used in Anginer and Yildizhan (2010) and discussed in detail in that paper. These results are summarized in Table 1. Aggregate volatility, _totvol_ , is measured using daily returns over the previous 12 months. o _-score_ is the Ohlson (1985) default score.<sup>88</sup> Idiosyncratic volatility, _idiovol_ , is calculated relative to the Fama-French 3- factor model.<sup>89</sup> _bm_ is the book-to-market ratio. _lme_ is the log of market capitalization. _nimtavg_ measures profitability and is calculated as a geometrically declining average of past values of the ratio of net income to the market value of total assets. Leverage is measured by _tlmta,_ which is the ratio of total liabilities to the market value of total assets.

86 As a robustness check, we also examined industry-level unionization rates, which are obtained from the Union Membership and Coverage Database (Unionstats). This database provides annual industry estimates at the 4-digit level. Results, however, do not substantially differ from the reported results employing firm-level unionization rates. Moreover, there is a 58% correlation between firm- and industrylevel unionization rates.

87 As a robustness check, we also employed alternative methodologies: (i) we used different percentages (20% and 50%) to define a unionized company; and (ii) we sorted companies into, alternatively, three buckets and five buckets, based upon unionization rates. Results, however, do not substantially differ from the reported results employing the 30% unionization definition. 88 O-score is defined as: _o_ -score = - 1.32 - 0.407 log( _SIZE_ ) + 6.03 _T LT A_ - 1.43 _W CT A_ + 0.076 _CLCA_ - 1.72 _OENEG_ - 2.37 _NIT A_ - 1.83 _FUT L_ + 0.285 _INT W O_ - 0.521 _CHIN_ where _SIZE_ is total assets divided by the consumer price index, _TLTA_ is the ratio of total liabilities to total assets, _CLCA_ is the ratio of current liabilities to current assets, _OENEG_ is a dummy variable set equal to one if total liabilities exceeds total assets and zero otherwise, _NITA_ is the ratio of net income to total assets, _FUTL_ is the ratio of funds from operations to total liabilities, _INTWO_ is a dummy variable equal to one if net income was negative for the past two years and zero otherwise, and _CHIN_ is change in net income over the last quarter: ( _NIt-NIt−1_ )/(| _NIt_ | + | _NIt−1_ |).

89 We regress daily stock returns from the previous calendar year on the Fama-French 3 factors: r _ti_ = _a i_ + _b MKTi MKT t_ + _bSMBi SMB t_ + _bHMLi HMLt_ + _eti_ . Idiosyncratic volatility is then calculated as the standard deviation of the residuals: var(<sup>_e_</sup> _ti_ )<sup>.</sup> 24
_chs-pd_ is the default probability, calculated as in Campbell, Hilscher and Szilagyi (2008).<sup>90</sup> _Merton-DD_ is the Merton (1974) distance-to-default measure. The computation of _merton-DD_ is described in detail in Anginer and Yildizhan (2010). _Rating_ is the S&P 500 rating, where the rating has been converted to numeric values (AAA = 1, ..., C = 13). Finally, _maturity_ is the average maturity of the bonds for a firm and is measured in years.

Table 1 reports that, along most of the financial characteristics described above, unionized and non-unionized companies are similar. The results indicate that, relative to the non-unionized companies, the unionized companies are less profitable, have bonds with slightly longer maturities, and have slightly lower-ranked ratings. Unionized companies are also larger and have more liabilities relative to assets. But with respect to other financial ratios and credit risk measures, we do not see statistically significant differences. That is, unionized and non-unionized companies are the same in terms of aggregate volatility, idiosyncratic volatility, default probability, distance to default, and default score. These results suggest that the two set of companies have similar creditriskiness characteristics.

# **VI. Results**

In this section, we examine yields and returns on corporate bonds over the 2008 and 2009 period. We then conduct an event study of abnormal bond returns on key event dates relating to the Chrysler bailout.

Figure 2 shows the yields on bonds of unionized companies and non-unionized companies. Results are shown separately for high-yield and investment-grade bonds. For investment grade bonds, the yield on bonds of unionized companies tracks the yield on bonds of non-unionized companies for most of 2008. Around September, 2008,

> 90 _chs-pd_ is defined as:

_CHSPD_ = 1 æççççè1 + exp æççççè-+ 9.1641.411 - _SIGMA_ 20.264 _t_ - _NIMT AAVG_ 0.045 _RSIZEt_ + _t_ -1.416 2.132 _T LMT ACASHMT At_ - 7.129 _t_ + 0.075 _EXRET AVGMB t_ - 0.058 _t PRICE t_ öö÷÷÷÷÷÷÷÷÷÷øø where _NIMTAAVG_ is a geometrically declining average of past values of the ratio of net income to the market value of total assets, _TLMTA_ is the ratio of total liabilities to the market value of total assets, _EXRETAVG_ is a geometrically declining average of monthly log excess stock returns relative to the S&P 500 index, _SIGMA_ is the standard deviation of daily stock returns over the previous three months, _RSIZE_ is the log of the ratio of market capitalization to the market value of the S&P 500 index, _CASHMTA_ is the ratio of cash to the market value of total assets, _MB_ is the market-to-book ratio, and _PRICE_ is the log of the price per share truncated from above at $15.

25
however, the yield of “non-unionized” bonds spikes, while the yield of “unionized” bonds remains flat. In other words, the price of the non-unionized bonds in the secondary market dropped in late 2008, with the worsening of the financial crisis, while the prices of the unionized bonds held steady. The stability of the unionized bond prices is consistent with investors’ expectations of public support for unionized companies. Investors perceived unionized bonds to be less risky than the non-unionized bonds during the crisis.

More interesting than investment-grade bonds, however, are high-yield bonds. Since the high yield bonds pose a greater risk of non-payment, their yields should be more sensitive to government policies. Figure 2 shows that the high-yield bonds follow a trend similar to, but more pronounced than, that of the investment-grade bonds.

With respect to the high-yield bonds, the yield for unionized companies tracks the yield for non-unionized companies during 2008. Yields on both unionized and nonunionized bonds spike in the latter part of 2008, with the worsening of the financial crisis. In early 2009, however, the yield on non-unionized bonds shoots above that of unionized bonds. And this spread between yields persists through the remainder of 2009.

Again, the relatively lower yield on the unionized bonds (i.e., their relatively higher price in the secondary market) reflects investor’s expectations of public support for the unionized firms. As with investment-grade bonds, investors in high-yield bonds perceive the unionized bonds to be less risky than the non-unionized bonds during the crisis.

These results are generally consistent with earlier studies finding that firms in more unionized industries have lower bond yields (e.g., Chen, Kacperczyk, and OrtizMolina 2010b). By focusing on the 2008-09 period, our study demonstrates that the findings of earlier studies continue to hold during a financial shock and economic recession, and that the trends are exaggerated by the adoption of a public bailout policy.

Figure 3 shows cumulative raw returns on bonds of unionized firms versus nonunionized firms over the 2008-09 period. The bonds of unionized firms generate greater cumulative returns than the bonds of non-unionized firms. The difference in cumulative returns over the period amounts to nearly 20%. Moreover, this differential is generated during the sub-period from the onset of the financial crisis in September, 2008 to the 26
completion of the Chrysler bailout in mid-2009. There is no perceptible differential in returns in first half of 2008, and the differential does not change in the second half of 2009.

We also examine cumulative returns on a risk-adjusted basis. Following Bessembinder et al. (2009) we group all bonds into four S&P rating categories, and compute value-weighted returns for all bonds falling into each of the rating groups.<sup>91</sup> We do not further partition by size or time-to-maturity due to the fact that a number of bonds do not trade on a daily basis; thus finer partitions result in small sample sizes within each partition. Cumulative risk-adjusted returns are shown in Figure 4. Cumulative riskadjusted returns for both unionized and non-unionized firms drop with the worsening of the financial crisis in late 2008. But the cumulative returns of unionized firms recover more quickly. The spread in the returns widens during the spring of 2009, with the fashioning of the auto bailout. As with the raw returns, the difference in cumulative riskadjusted returns amounts to about 30% over the period studied.

Over the period we study, there is no evidence that investors were worried about political interference in unionized firms as a consequence of the bailouts. To the contrary, investors reacted positively to the prospect of public support.

We also undertake an event study of bond returns in order to pinpoint when and how the bailout impacted the credit market. Key event dates relating to the bailout are set forth in the Appendix hereto. To compute abnormal returns, we use the five-factor bond model developed in Fama and French (1993). This model is an extension of the commonly used three-factor stock return model, which includes factors for the market risk premium (or MKT), firm size (small minus big, or SMB), and value (high minus low, or HML). The bond model adds two additional factors: TERM, which represents the slope of the Treasury yield curve, and DEF, the default premium measured as the difference between the returns on long-term corporate bond indices and long-term Treasuries. Formally, the model developed by Fama and French to estimate expected bond returns is:

> 91 The rating groups are (i) AAA to AA-; (ii) A+ to A-; (iii) BBB+ to BBB-; and (iv) BB+ to C.

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_i i i i i i i R_ = _a_ + _b MKT_ + _b SMB_ + _b HML_ + _b DEF_ + _b T ERM t MKT t SMB t HML t DEF t T ERM t_ + _bDUMMYi DAT E_ DUMMY t_ + _eti_ To the model, we add a dummy variable, _DATE_DUMMY_ , that takes on a value of one during a three-day window around the event dates ( _t-1, t, t+1_ ) which we study in this paper.<sup>92</sup> The results from these regressions are reported in Table 2 for unionized companies (Panel A), non-unionized companies (Panel B), and the difference between unionized and non-unionized companies (Panel C). The coefficient on the dummy variable represents the abnormal return on the bonds during the event window. It captures the impact of the event on bond returns.

# (a) The Bush Administration Approves Use of TARP Funds for Chrysler and GM

_December 12, 2008._ The Bush administration suggested, on December 12, 2008, that Chrysler and General Motors might be eligible for TARP funds. This announcement reversed Treasury Secretary Paulson’s position that TARP funds would be used to help only financial institutions. The administration’s announcement was prompted by the Senate’s rejection of a legislative bailout package for the auto companies on December 11. That legislation failed in the Senate because Republicans were demanding deep concessions from the labor union as part of any bailout. The legislative failure prompted the Bush administration, on the morning of December 12, to declare that it would be “irresponsible” to let the auto companies fail, and that it would consider using the TARP funds.

The bonds of unionized companies did not respond to this reversal of position by the Bush administration. The coefficient on the date dummy is insignificant for unionized companies (Panel A), indicating that the announcement did not have a significant impact on bond returns of unionized companies. The announcement did not have a significant impact on bond returns of non-unionized companies (Panel B) either. It may be that the possibility of a bailout was still too uncertain. That uncertainty, however, was resolved on December 19.

> 92 We find similar results using simply the event dates, and  using a five-day window around event dates.

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_December 19, 2008._ The Bush administration announced, on December 19, 2008, that it would lend Chrysler and GM a combined total of $17.4 billion from TARP funds.

The bonds of unionized companies responded positively to the announcement. Those bonds generated significant positive abnormal returns upon the bailout announcement. The announcement added approximately 0.77% to the daily returns on bonds of unionized companies. The bonds of non-unionized companies, in contrast, exhibited no response. The difference in the abnormal returns of the two types of companies was a statistically significant one, amounting to 1.27% on a daily basis.

The significant positive impact of the announcement on unionized bond returns is surprising given the announcement’s tough treatment of Chrysler’s bondholders. The TARP loans required that the auto company meet certain targets, including replacing two-thirds of its debt with stock (as well as using stock instead of cash to fund retiree health care obligations, and establishing wage structures and workplace rules that are more competitive with foreign rivals), though the targets were non-binding. Moreover, the TARP loans would become due if, by March 31, the company failed to extract sufficient concessions from creditors, workers, suppliers, dealers, and other stakeholders to establish long-term viability. And, oversight would fall to the incoming Obama administration, which was strongly backed by the UAW.<sup>93</sup> In fact, both the UAW and certain members of Congress signaled, on this date, that they would wait for the Obama administration to enter before making concessions in negotiations.

The significant positive impact on unionized bond returns is also surprising given that the loans drained what remained of the first half of the $700 TARP funds. To make additional loans to Chrysler or other companies from the TARP funds, the administration would have to approach Congress. However, on this date, Secretary Paulson stated that Congress should release the second $350 billion of TARP funds. But Paulson did not formally make that request to Congress, stating that the formal request would happen “in the near future” after consulting with the incoming Obama administration.

# (b) Congress Fails to Block Second Half of TARP Funds

> 93 Unions spent $52 million to help elect Obama.  Salas, _supra_ note 9.

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Under the TARP legislation passed in October, 2008, Congress was authorized to block the release of the second half of the $700 billion of TARP funds. Congress could block the release only if both the House and Senate voted to do so (though the President could veto any legislation). A resolution of disapproval was submitted to both the House and Senate for a vote, passage of which would block Treasury’s access to the remaining TARP funds. Some members of Congress wanted to scrap TARP, some wanted to impose new conditions on any additional funds, and some wanted to dedicate funds to preventing foreclosures. Hence, Treasury’s access to the second half of TARP funds for the auto bailout was not a certainty.

_January 15, 2009._ On this date, the Senate voted 52-42 to defeat a resolution blocking the release of the additional TARP funds. Since both chambers had to pass such a resolution to block the release of the funds, a House vote was consequently rendered moot and access to the remaining funds was assured. However, bond returns did not exhibit a significant response to the vote.

While we use January 15, 2009, the date the Senate approved access to the TARP funds, as the event date, events on the prior day were also important. On January 14, 2009, Obama officials gave Senate Republicans assurances they were seeking that the additional TARP funds would be used only for the auto, banking, and housing industries and not for a broader industrial policy. Such assurances made Congressional support for the auto bailout more likely. Thus, January 14 was an important date. And our event window around January 15 encompasses it. Bond returns, however, were not impacted by the events on January 14 and 15.

# (c) The Treasury Issues Results of its Viability Review

In February, 2009, Chrysler submitted to the Treasury its plan to achieve longterm viability. Submission of an acceptable viability plan was a requirement attached to the TARP loans the auto companies received in December.

_March 29, 2009._ After reviewing the viability plan submitted by Chrysler, the Treasury announced a summary of its findings on March 29, 2009. The Treasury made the following findings: 30
- Chrysler is not viable as a stand-along company and must merge with Fiat.

- The best chance for success would “require utilizing the bankruptcy code in a quick and surgical way.”

- The company will have additional time (30 days) to produce a new, more aggressive  viability plan, in order to pursue an alliance with Fiat (or another company) and to gain bigger concessions from stakeholders, particularly creditors and the UAW.  If an acceptable plan is not submitted by then, government support will end and bankruptcy will be the likely course.

The findings indicated that Treasury intended to intervene more deeply than expected into the affairs of the auto company.

Bond returns, however, did not respond in a significant manner. Treasury’s announcement had an insignificant impact on bonds of unionized and non-unionized companies.

_March 30, 2009._ Following up on the summary announced the day before, President Obama and the Treasury released more details, including term sheets.

Treasury indicated that Chrysler’s survival “at a minimum would require extinguishing the vast majority of Chrysler’s outstanding secured debt and all of its unsecured debt and equity.” The Treasury, however, did not explicitly mention any cuts for retirees or reductions in Chrysler’s legacy costs. According to the media, the announcement surprised some secured creditors, who believed they would fare better without government intervention. One of the creditors stated, “If you are a secured lender, you expect to come out on top. I hope the government isn’t saying it has the right to reshuffle the decks.”<sup>94</sup> Nevertheless, bond returns did not react. Abnormal returns on bonds of unionized and non-unionized companies were not significantly different from zero.

# (d)  Litigation

> During the _Chrysler_ bankruptcy proceedings, certain secured first-priority debt holders, three Indiana state pension funds, objected to the proposed reorganization.  The funds argued that the scheme would violate the Bankruptcy Code by impermissibly subordinating their interests as secured lenders.  They claimed that the sale would violate

> 94 Kate Linebaugh, _Detroit’s New Model: Chrysler Plan Trims Fiat’s Stake_ , WALL ST. J., March 31, 2009.

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bankruptcy priority rules by paying unsecured creditors while secured creditors were receiving only 29 cents on the dollar. The funds also argued that the first-lien debt holders could recover more in liquidation, and that Chrysler could sell the assets for more than the $2 billion New Chrysler had offered. The bankruptcy court denied the funds’ motion<sup>95</sup> and approved the reorganization. The funds immediately appealed. The Second Circuit issued an order ratifying the bankruptcy court’s decision, and issued a stay to allow for review by the U.S. Supreme Court. Although the Supreme Court initially granted a temporary stay, it vacated the stay on the next day.<sup>96</sup> Upon remand, the Second Circuit affirmed<sup>97</sup> the bankruptcy court’s decision.<sup>98</sup> The relevant dates are April 30, June 1, June 2, June 5, June 8, June 9, June 10, July 5, and August 5, as set forth in the Appendix.

None of these event dates, however, produces a significant impact on bond returns. The structure of the Chrysler reorganization was challenged but upheld in the bankruptcy court, the Second Circuit, and the U.S. Supreme Court. Yet, none of those decisions generated significant abnormal returns on bonds of unionized or non-unionized companies.

# **VII. Conclusion**

We find that bondholders responded positively to the government’s decision to assist Chrysler. That is, bondholders approved of the bailout decision.

But in contrast to their positive reaction to the initial bailout decision, bondholders exhibited no reaction to the specific terms of the bailout that emerged over the subsequent months and that purportedly favored the union over secured creditors. Bondholders also shrugged of the court decisions that put a judicial stamp of approval on the arrangement. The results reject the argument of the bailout’s critics, that the bailout would be perceived by bondholders as establishing a precedent for future subordination of creditors in bankruptcy.

> 95 Order Denying Emergency Motion of the Indiana Pensioners for Stay of Proceedings Pending Determination of Motion to Withdraw the Reference (May 20, 2009), _In Re_ Chrysler LLC, S.D.N.Y. (No. 09 B 50002 (AJG)) (online at chap11.epiqsystems.com/docket/docketlist.aspx?pk=1c8f7215-f675-41bfa79be1b2cb9c18f0&l=1).

> 96 Ind. State Police Pension Trust v. Chrysler LLC, 129 S. Ct. 2275, 2276 (2009) (per curiam).

> 97 _Chrysler II_ , 576 F.3d 108, 127 (2d Cir. 2009).

> 98 _Chrysler I_ , 405 B.R. 79, 83 (Bankr. S.D.N.Y. 2009).

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Instead, the results support the notion that government bailouts generate moral hazard in the financial markets. The results show that the Chrysler bailout led investors to expect additional bailouts of troubled companies in the future. After the government allowed Lehman Brothers to fail in September of 2008, there was reason for credit markets to doubt whether the government would support troubled firms. With Chrysler, the government signaled its willingness to stand behind large, struggling companies, especially those with high unionization rates. As a result of this signal that large, unionized companies have become too-big-to-fail, investors believed that the debt of these companies had become less risky.

The perception that certain large troubled companies have become public bailouts candidates has economy-wide ramifications. It enables such troubled companies to borrow more cheaply than they could in the absence of an implicit government guarantee. Hence, capital flows to firms that should otherwise fail. In this respect, the Chrysler bailout will have unfortunate consequences for the economy.

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