Sunday, March 11, 2012

Eminent domain: Being a bondholder ain't what it used to be!

Pity the poor bondholder who faces the wrath of government!

Senior debt, bond indentures and full faith and credit are investing terms that just don't seem to mean what they used to mean!

For those bond buyers who may choose to go for the added security of the senior debt of a corporation and who are willing to give up some return for the privilege, say General Motors (see GM bondholders below);

For bond buyers who have confidently placed their belief (and money) behind the full faith and credit backing of some city, state or sovereign issuer; and

For those bond buyers who believe that what a bond indenture says is sacrosanct and protected by the law:

Perhaps it is time to invest in something a little more reliable and regulated like the inventory in a pawn shop!

Wall Street etiquette!

Wall Street has always operated under the auspices that your word is your bond and that if you ever violated that bond you were in effect, finished.

For example if a trader refused to acknowledge a trade that they entered into they might win that battle, but because other traders will no longer do business with them they will have lost the war.

That same truth had always applied to investment firms as well although that line through the years has been dulled and at times violated.

So what happens to an industry, specifically investments, when unceremoniously and without warning the rules of the game are changed by outside influences and the luster of the "public trust" is tarnished?

For example, what would you call the US government (although it could have been the old Soviet regime) inserting itself into the financial markets and mandating (some might call it strong-arming) that senior bondholders accept a junior lien position in order to serve what is called the greater good of the people, or else?

Is it a stretch to say that represent a type of eminent domain applied to the investment world (see eminent domain definition below)?

And if Greece can put a retroactive collective action clause (CAC) into effect that triggers a default (as reported Friday) doesn't that represent a further diminution of bondholder security and rights?

While it may have been allowable under some terms of the indenture it may make finding investors in other country debt such as Portugal, Ireland or Italy more difficult. In the investing world more difficult equals higher yields needed to be paid to entice those investors, something that these countries cannot afford to do!

Of course the one factor working in Wall Street's and the issuers favor is that they are the only game in town for institutional fixed income investors who have trillions to invest with a fiduciary responsibility to get it done.

On the other hand, while these actions by sovereign governments may have served some short-term purpose under stressful circumstances and the government won the proverbial battle, in the longer-term scheme of the capital markets and institutional investors is it possible that by abusing the public trust that they have lost the war?

Only time will tell but remember that old saying that may have some relevance in this case, "once burned, twice shy"!

Eminent domain: "... The property of subjects is under the eminent domain of the state, so that the state or he who acts for it may use and even alienate and destroy such property, not only in the case of extreme necessity, in which even private persons have a right over the property of others, but for ends of public utility, to which ends those who founded civil society must be supposed to have intended that private ends should give way. But it is to be added that when this is done the state is bound to make good the loss to those who lose their property." (Wikipedia)

General Motors senior bondholders in bankruptcy workout: "...The bankruptcy was challenged from the start by bondholders, who held $27 billion in GM debt. Senior bondholders, by law, are supposed to receive 100% of assets before anyone else gets anything. However, the bankruptcy judge gave them a minor 10% stake of the company. In contrast, the union, for $20 billion owed to its health trust, received 17% if the stock, $2.5 billion in cash and $6.5 billion in preferred stock. So the union received over three times in value what the secured debt holders received and they should have been behind them receiving anything at all. The government, for $50 billion, received 61% of the company, also disregarding the senior bond holder's first-place position.

Many bondholders were furious, and rightfully so. There is anecdotal evidence that there was threats and strong-arming that eventually had them back down. Here is a clip of the transcript of a radio interview of Thomas Laurie, the attorney representing the Chrysler creditors at the time:

Lauria: "Let me tell you it's no fun standing on this side of the fence, opposing the President of the United States. In fact, let me just say, people have asked me who I represent. That's a moving target. I can tell you for sure that I represent one less investor today than I represented yesterday. One of my clients was directly threatened by the White House and in essence compelled to withdraw its opposition to the deal under the threat that the full force of the White House Press Corps would destroy its reputation if it continued to fight. That's how hard it is to stand on this side of the fence."

This administration's actions in designing the GM bankruptcy was gangster-like and an outrageous disregard of bankruptcy law. The Obama administration essentially confiscated the assets of the bondholders and gave them to the union; wealth distribution at its finest! If this is what it took for GM to remain alive, should it be alive..." (Source)

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