It's now been ten days since Barack Obama's speech in Cairo. I've finally taken the time out to read the transcript - you can read it here. Obama focused on "a new beginning" between the U.S. and the Muslim world. He concentrated on seven key issues...
1. Violent Extremism: Obama stated that the U.S. is "not at war with Islam" and that the war in Afghanistan is a "necessity" while the Iraq War was one of "choice." I'm very concerned with his basic criteria for success in Afghanistan that "we would bring every [troop] home if we could be confident that there were not violent extremists in Afghanistan and now Pakistan determined to kill as many Americans as they possibly can." To me, this is an unachievable goal - especially, considering our policy to be at war in these countries.
2. Israel and Palestine: Obama called for a two-state solution with an independent Palestine living alongside Israel in peace. He called America's bond with Israel "unbreakable" and based upon "cultural and historical ties, and the recognition that the aspiration for a Jewish homeland is rooted in a tragic history that cannot be denied." Well, that makes it clear to me! This is the basis for our alliance with Israel? Despite the special relationship with Israel, Obama did call for Israel to put a stop to settlements in the West Bank. This placed Prime Minister Benjamin Netanyahu in a precarious position which he addressed in a speech this weekend (more below).
3. Nuclear Weapons: Obama, the leader of the country with the largest military budget and most nuclear weapons in the world, dreamed of a world with no nuclear weapons. He acknowledged Iran's right to pursue nuclear energy, stated that "no single nation should pick and choose which nation holds nuclear weapons," but said that Iran cannot have nukes (while not explicitly saying those words).
4. Democracy: Here Obama stated that "no system of government can or should be imposed by one nation by any other." Nice words, but I am skeptical that we will follow through on that.
5. Religious Freedom: Kumbaya stuff.
6. Women's Rights: More kumbaya.
7. Economic Development and Opportunity.
Overall, I thought it was a good speech, but will likely lead to undelivered promises. American relations with the Muslim world has been filled with tension for decades. One speech will not make a difference, but could lead to a new beginning. Obama addressed some of the issues which have led to the tension (such as our participation in the 1953 coup d'etat in Iran), but did not go so far as an outright apology. He also reiterated our commitment to the continuation of policies which have contributed to the tension. We will watch this as it unfolds with great interest.
*****
As noted, Israeli Prime Minister Benjamin Netanyahu delivered an important speech this weekend which addressed the way forward in Israeli-Palestinian relations juxtaposed against Obama's speech in Cairo. The full text can be read here. Netanyahu, generally considered more hawkish towards and less supportive of the Palestinians, stated he would support a Palestinian state. However, there were a lot of conditions which are unlikely. A summary can be read here.
*****
The special session is underway in the Indiana legislature with the key goal of passing a budget. I will try to follow this more closely over the coming weeks.
Sunday, June 14, 2009
Thursday, June 11, 2009
No smoking
Today, the Senate voted 79-17 to pass H.R. 1256, AKA the "Family Smoking Prevention and Tobacco Control Act." This vote sends the bill back to the House for a vote there; if it's passed by the House it goes directly to President Obama to sign. The Senate version of the bill is quite similar to the original House version which passed 298-112 (21 no votes) so it seems rather likely that it will pass.
This is the federal government's latest attempt to essentially FORCE people to stop smoking, of course in a roundabout way. Unfortunately, it seems to me that the bill will likely pass and when it does, there will be yet another example of the government butting its way into all facets of our lives and telling us what to do...each passage of such a bill, I think, moves us closer and closer to socialism. And we're already too close...
In the name of "protecting children" and "protecting America," the bill will place tobacco products under the supervision of the FDA, who would be charged with evaluating the content of tobacco products and then ORDERING CHANGES to those deemed "a danger to public health." Note here the extremely ambiguous phrase "danger to public health." That is just begging to be abused...who's to say what is dangerous to public health? I'm also betting the federal government won't label something like Viagra as a threat to public health...they'd lose too many contributions from Pfizer.
The bill also particularly singles out practices by tobacco manufacturers that are said to be geared toward attracting new, young smokers. This includes prohibiting "candy or other flavors" in cigarettes, prohibiting the labeling of cigarettes as "light" or "mild," and restricting advertising in certain publications that are geared toward a teenage audience. In the end, this all leads to giving the FDA the ultimate decision in whether or not a new tobacco product will be allowed to go on the market--if the FDA doesn't approve, then it doesn't happen.
Now, it seems to me that cigarettes, etc. don't really fall under the category of either "food" or "drugs" so it doesn't seem like the FDA has any business regulating tobacco products. The Republican leader of the opposition to the bill, Sen. Richard Burr of North Carolina, proposed an amendment that would create an entirely new agency to regulate tobacco products. I certainly don't like or agree with the idea of creating more government agencies and increasing government regulation but I'm guessing that the opposition saw that the bill was going to pass regardless and attempted to at least make an effort at something less restrictive. That effort, not surprisingly, failed.
In closing, here are a few quotes from the proponents of this bill in the Senate, as well as President Obama--
"This is a bill that will protect children and will protect America. Every day that we don't act, 3,500 American kids -- children -- will light up for the first time. That is enough to fill 70 school buses." --Sen. Dick Durbin, D-Ill.
"This bill may do more in the area of prevention, if adopted, than anything else we may include in the health care bill in the short term." --Sen. Christopher Dodd, D-Conn.
Commenting on the impending passage of the bill, President Obama said that the bill "will make history by giving the scientists and medical experts at the FDA the power to take sensible steps."
This is the federal government's latest attempt to essentially FORCE people to stop smoking, of course in a roundabout way. Unfortunately, it seems to me that the bill will likely pass and when it does, there will be yet another example of the government butting its way into all facets of our lives and telling us what to do...each passage of such a bill, I think, moves us closer and closer to socialism. And we're already too close...
In the name of "protecting children" and "protecting America," the bill will place tobacco products under the supervision of the FDA, who would be charged with evaluating the content of tobacco products and then ORDERING CHANGES to those deemed "a danger to public health." Note here the extremely ambiguous phrase "danger to public health." That is just begging to be abused...who's to say what is dangerous to public health? I'm also betting the federal government won't label something like Viagra as a threat to public health...they'd lose too many contributions from Pfizer.
The bill also particularly singles out practices by tobacco manufacturers that are said to be geared toward attracting new, young smokers. This includes prohibiting "candy or other flavors" in cigarettes, prohibiting the labeling of cigarettes as "light" or "mild," and restricting advertising in certain publications that are geared toward a teenage audience. In the end, this all leads to giving the FDA the ultimate decision in whether or not a new tobacco product will be allowed to go on the market--if the FDA doesn't approve, then it doesn't happen.
Now, it seems to me that cigarettes, etc. don't really fall under the category of either "food" or "drugs" so it doesn't seem like the FDA has any business regulating tobacco products. The Republican leader of the opposition to the bill, Sen. Richard Burr of North Carolina, proposed an amendment that would create an entirely new agency to regulate tobacco products. I certainly don't like or agree with the idea of creating more government agencies and increasing government regulation but I'm guessing that the opposition saw that the bill was going to pass regardless and attempted to at least make an effort at something less restrictive. That effort, not surprisingly, failed.
In closing, here are a few quotes from the proponents of this bill in the Senate, as well as President Obama--
"This is a bill that will protect children and will protect America. Every day that we don't act, 3,500 American kids -- children -- will light up for the first time. That is enough to fill 70 school buses." --Sen. Dick Durbin, D-Ill.
"This bill may do more in the area of prevention, if adopted, than anything else we may include in the health care bill in the short term." --Sen. Christopher Dodd, D-Conn.
Commenting on the impending passage of the bill, President Obama said that the bill "will make history by giving the scientists and medical experts at the FDA the power to take sensible steps."
Tuesday, June 9, 2009
More On Chrysler
If you haven't already heard, the Supreme Court has lifted the stay which had put the Fiat sale on hold. Earlier today, Fiat CEO Sergio Marchionne stated that they would not walk away from the deal. That did not matter however as the high court's decision was unanimous. You can review the actions of the court at SCOTUS blog.
I've heard a little bit today both from the local media and the MSM regarding the issue before the court both before and after the decision was rendered. I have to say that either I'm totally missing something or the media is either dumb or dishonest (I won't rule out both). However, a couple of people I have some respect for as commentators (Abdul Hakim-Shabbaz and Judge Andrew Napolitano) are on the list, so maybe I just don't get it.
I did a good deal of research on the Chrysler bankruptcy (read here), and while I don't necessarily like the outcome, the government-supported-pro-UAW-Fiat-Sale looks to be legal. I'm not surprised that the Supreme Court has dismissed the grievances - especially based on the legal merit of the case.
The 363 sale, as I understand it, has become more common in bankruptcy and occurs outside of the restructuring or liquidation which happens in Chapters 11 and 7 respectively. I'd best describe it as a hybrid of restructuring and liquidation where an outside bidder submits a "super bid" for most of the bankrupt company. As long as a) it is the best available bid, b) the bankrupt company and debtors-in-possession agree to the sale, and c) the value of the assets could decline substantially in the absence of a sale. (Note: Judge Gonzalez's ruling provides a more detailed and accurate explanation and can be read in full if desired - I've linked to it in my previous article linked above. Alternatively, you can Google "criteria for a 363 sale" or something of that sort.) The Fiat transaction meets these criteria.
It is unfortunate that the U.S. government is playing such a heavy hand by financing the Old Chrysler, helping fund Fiat in creating the New Chrysler, and putting pressure on the big name creditors who have received TARP money. But, this is where the Indiana Funds probably lack standing. The notion of standing is one which is bothersome to me in general. I understand why standing is required so that we avoid clogging up the courts with frivolous lawsuits, but it seems that some fundamental Constitutional questions remain unchallenged since no one has standing.
Ok. Anyways... I'd love it if some bankruptcy and constitutional experts happen to come across this post and can chime in. But, as I see it, the senior secured creditors may be losing out in this deal, but it appears to be both legal and their best available option. And, yes, the UAW VEBA is making out quite nicely (on a relative basis), but this is due to an independent deal struck with "New Chrysler" (supported by both Fiat and the U.S. and Canadian governments) and outside of the purview of the bankruptcy itself. The proceeds from liquidating the assets which will remain with the Old Chrysler as well as the $2B paid by the New Chrysler will be paid to the secured creditors under "normal" bankruptcy law (i.e. they are paid before the unsecured creditors or equity holders).
By the way, I do agree that this whole mess will have implications of sort on the desirability of investing in the bond market. However, the 363 sale is legal, has been widely used in other cases, and can "screw" secured creditors. This highly publicized case may place pressure on the future use of 363 sales and/or introduce higher interest rates (and more risk) on corporate bonds.
If you want to read even more details on the ins and outs of bankruptcy, Credit Slips is a very good site. Incidentally, Elizabeth Warren, the chair of the Congressional Oversight Panel for TARP, is a contributor.
I've heard a little bit today both from the local media and the MSM regarding the issue before the court both before and after the decision was rendered. I have to say that either I'm totally missing something or the media is either dumb or dishonest (I won't rule out both). However, a couple of people I have some respect for as commentators (Abdul Hakim-Shabbaz and Judge Andrew Napolitano) are on the list, so maybe I just don't get it.
I did a good deal of research on the Chrysler bankruptcy (read here), and while I don't necessarily like the outcome, the government-supported-pro-UAW-Fiat-Sale looks to be legal. I'm not surprised that the Supreme Court has dismissed the grievances - especially based on the legal merit of the case.
The 363 sale, as I understand it, has become more common in bankruptcy and occurs outside of the restructuring or liquidation which happens in Chapters 11 and 7 respectively. I'd best describe it as a hybrid of restructuring and liquidation where an outside bidder submits a "super bid" for most of the bankrupt company. As long as a) it is the best available bid, b) the bankrupt company and debtors-in-possession agree to the sale, and c) the value of the assets could decline substantially in the absence of a sale. (Note: Judge Gonzalez's ruling provides a more detailed and accurate explanation and can be read in full if desired - I've linked to it in my previous article linked above. Alternatively, you can Google "criteria for a 363 sale" or something of that sort.) The Fiat transaction meets these criteria.
It is unfortunate that the U.S. government is playing such a heavy hand by financing the Old Chrysler, helping fund Fiat in creating the New Chrysler, and putting pressure on the big name creditors who have received TARP money. But, this is where the Indiana Funds probably lack standing. The notion of standing is one which is bothersome to me in general. I understand why standing is required so that we avoid clogging up the courts with frivolous lawsuits, but it seems that some fundamental Constitutional questions remain unchallenged since no one has standing.
Ok. Anyways... I'd love it if some bankruptcy and constitutional experts happen to come across this post and can chime in. But, as I see it, the senior secured creditors may be losing out in this deal, but it appears to be both legal and their best available option. And, yes, the UAW VEBA is making out quite nicely (on a relative basis), but this is due to an independent deal struck with "New Chrysler" (supported by both Fiat and the U.S. and Canadian governments) and outside of the purview of the bankruptcy itself. The proceeds from liquidating the assets which will remain with the Old Chrysler as well as the $2B paid by the New Chrysler will be paid to the secured creditors under "normal" bankruptcy law (i.e. they are paid before the unsecured creditors or equity holders).
By the way, I do agree that this whole mess will have implications of sort on the desirability of investing in the bond market. However, the 363 sale is legal, has been widely used in other cases, and can "screw" secured creditors. This highly publicized case may place pressure on the future use of 363 sales and/or introduce higher interest rates (and more risk) on corporate bonds.
If you want to read even more details on the ins and outs of bankruptcy, Credit Slips is a very good site. Incidentally, Elizabeth Warren, the chair of the Congressional Oversight Panel for TARP, is a contributor.
Garbage Everywhere
I'm watching CNBC right now and can't help but become terribly irritated. First, they have an unapologetic Democrat on who does nothing but whine, argue, blame Republicans, and say things like, "is there anything that this President can do that you guys would like?" to her fellow panelists.
Then, you have the pro-business, anti-Obama guy spouting his own rhetoric. He did not irritate me as much, but, that's just because he couldn't get much of a word in edge-wise against panelist #1.
Argh. There is no fact-checking; just a lot of "blah, blah, blah... Democrats suck! Oh yeah, no way! Republicans suck!" Seriously!? Is this our media? (That's rhetorical... I like calling it mediatainment.)
Surprisingly, I haven't heard the phrase "green shoots" yet tonight on CNBC; although, I haven't been paying that much attention.
Just venting...
Then, you have the pro-business, anti-Obama guy spouting his own rhetoric. He did not irritate me as much, but, that's just because he couldn't get much of a word in edge-wise against panelist #1.
Argh. There is no fact-checking; just a lot of "blah, blah, blah... Democrats suck! Oh yeah, no way! Republicans suck!" Seriously!? Is this our media? (That's rhetorical... I like calling it mediatainment.)
Surprisingly, I haven't heard the phrase "green shoots" yet tonight on CNBC; although, I haven't been paying that much attention.
Just venting...
Monday, June 8, 2009
The Chrysler Bankruptcy
Earlier this week, I wrote an article which provided some basic education on the topics of capital structure and bankruptcy. This may have been overly simple for some readers, but one goal here is to provide education so that our readers can better decipher the news. With these basic financial principles, we can explore the Chrysler bankruptcy in more detail.
By the middle of 2008, the so-called Big 3 (GM, Ford and Chrysler) were already in suspect financial condition. When the economy began to really flounder in September, it only served to push the already weak companies to the edge of the economic abyss. At the end of September, Congress passed legislation which would provide $25B in loan guarantees to the automobile industry. In November, the circus intensified in the height of bailout fever, when the three CEOs came to Washington to beg for money. Legislation was crafted and passed in the House to provide direct loans to the Big 3; it did not make it out of the Senate. In a legally and constitutionally questionable move, the White House dedicated TARP funds to provide loans to Chrysler and GM. Chrysler received $4B. The Obama adminstration created an auto Task Force which would review restructuring plans provided by the automakers. The Chrysler plan was not enough and they prepared for bankruptcy.
Chrysler is (was) a privately owned company with Cerberus Capital Management owning an 80.1% share of the company and the remaining equity held by Daimler AG. Daimler wrote off their ownership (i.e. determined that the value was equal to zero) in October of 2008. Besides the money which has lent/given by the U.S. and Canadian governments, Chrysler had $6.9B in outstanding senior secured debt. There is another $2B in junior debt held by Daimler and Cerberus; and, of course, there are the TARP loans which are even more junior on the majority of Chrysler's collateral. Additionally, the UAW had set up a Voluntary Employee Benefits Association (VEBA) which holds an unsecured claim against Chrysler. The VEBA was set up to take the responsiblity of health care benefits from the Big 3. Chrysler was obligated to pay $9B to the fund. (More detail on the VEBA can be found in this article.)
Since Chrysler was unable to fund its obligations to bondholders or find investors willing to save them from bankruptcy, they had to proceed with their filing on April 30. Throughout the month of May, the Bankruptcy Court of the Southern District of New York heard the case. The case proceeded with the intent to facilitate a "363 Sale" in reference to Section 363 of the Bankruptcy Code. This allows for a sale of selected assets and transfer to selected debts and obligations to be made while the remainder are either liquidated or restructured. The U.S. Tresuary has indicated that it will provide debtor-in-possesion (DIP) financing to Chrysler to continue operations while in bankruptcy only if a 363 sale could be executed in a "surgical bankruptcy". Enter Fiat.
Fiat, the Italian automaker, has offered "access to competitive fuel-efficient vehicle platforms, distribution capabilities in key growth markets and substantial cost-savings opportunities." A new corporation, New CarCo Acquisition LLC, was set up to be the purchasers of the selected parts of Chrysler in the 363 sale. Fiat has partnered with the VEBA, the U.S. government, and the Canadian government in the form of Export Development Canada as the owners of the "New Chrysler" with a 55% stake going to the VEBA, 8% to the U.S Treasury, 2% to Export Development Canada, and 20% to Fiat. Fiat will quickly receive a 35% share as the deal is finalized with rights to own as much as 51% after the government loans have been repaid. New Chrysler will pay $2B to "Old Chrysler" as part of the sale.
Now, there are objections to this plan. The most notable objection has been made by three Indiana pension funds: the Indiana State Teachers Retirement Fund, the Indiana State Police Pension Trust, and Indiana Major Moves Construction. These three funds purchased $42M of Chrysler debt at 43 cents on the dollar. Additionally, some consumer advocate groups, a group of dealers who will have their franchise agreements terminated, and others have all attempted to block the 363 sale. Last Monday, Judge Arthur Gonzalez denied all objections and approved the sale. His 47 page opinion can be read here. (I have read the whole thing in an effort to understand the details which has been the reason this article is as delayed as it is.)
By the middle of 2008, the so-called Big 3 (GM, Ford and Chrysler) were already in suspect financial condition. When the economy began to really flounder in September, it only served to push the already weak companies to the edge of the economic abyss. At the end of September, Congress passed legislation which would provide $25B in loan guarantees to the automobile industry. In November, the circus intensified in the height of bailout fever, when the three CEOs came to Washington to beg for money. Legislation was crafted and passed in the House to provide direct loans to the Big 3; it did not make it out of the Senate. In a legally and constitutionally questionable move, the White House dedicated TARP funds to provide loans to Chrysler and GM. Chrysler received $4B. The Obama adminstration created an auto Task Force which would review restructuring plans provided by the automakers. The Chrysler plan was not enough and they prepared for bankruptcy.
Chrysler is (was) a privately owned company with Cerberus Capital Management owning an 80.1% share of the company and the remaining equity held by Daimler AG. Daimler wrote off their ownership (i.e. determined that the value was equal to zero) in October of 2008. Besides the money which has lent/given by the U.S. and Canadian governments, Chrysler had $6.9B in outstanding senior secured debt. There is another $2B in junior debt held by Daimler and Cerberus; and, of course, there are the TARP loans which are even more junior on the majority of Chrysler's collateral. Additionally, the UAW had set up a Voluntary Employee Benefits Association (VEBA) which holds an unsecured claim against Chrysler. The VEBA was set up to take the responsiblity of health care benefits from the Big 3. Chrysler was obligated to pay $9B to the fund. (More detail on the VEBA can be found in this article.)
Since Chrysler was unable to fund its obligations to bondholders or find investors willing to save them from bankruptcy, they had to proceed with their filing on April 30. Throughout the month of May, the Bankruptcy Court of the Southern District of New York heard the case. The case proceeded with the intent to facilitate a "363 Sale" in reference to Section 363 of the Bankruptcy Code. This allows for a sale of selected assets and transfer to selected debts and obligations to be made while the remainder are either liquidated or restructured. The U.S. Tresuary has indicated that it will provide debtor-in-possesion (DIP) financing to Chrysler to continue operations while in bankruptcy only if a 363 sale could be executed in a "surgical bankruptcy". Enter Fiat.
Fiat, the Italian automaker, has offered "access to competitive fuel-efficient vehicle platforms, distribution capabilities in key growth markets and substantial cost-savings opportunities." A new corporation, New CarCo Acquisition LLC, was set up to be the purchasers of the selected parts of Chrysler in the 363 sale. Fiat has partnered with the VEBA, the U.S. government, and the Canadian government in the form of Export Development Canada as the owners of the "New Chrysler" with a 55% stake going to the VEBA, 8% to the U.S Treasury, 2% to Export Development Canada, and 20% to Fiat. Fiat will quickly receive a 35% share as the deal is finalized with rights to own as much as 51% after the government loans have been repaid. New Chrysler will pay $2B to "Old Chrysler" as part of the sale.
Now, there are objections to this plan. The most notable objection has been made by three Indiana pension funds: the Indiana State Teachers Retirement Fund, the Indiana State Police Pension Trust, and Indiana Major Moves Construction. These three funds purchased $42M of Chrysler debt at 43 cents on the dollar. Additionally, some consumer advocate groups, a group of dealers who will have their franchise agreements terminated, and others have all attempted to block the 363 sale. Last Monday, Judge Arthur Gonzalez denied all objections and approved the sale. His 47 page opinion can be read here. (I have read the whole thing in an effort to understand the details which has been the reason this article is as delayed as it is.)
With the Old Chrysler receiving $2B from the New Chrysler, and essentially no assets remaining in the Old Chrysler of any value, the creditors (bondholders) stand to receive the $2B for the $6.9B in secured debt. This equates to about 29 cents on the dollar. There is a trust which had been established to serve the interests of the senior secured creditors who agreed to this deal in near unanimity. It has been the Indiana Funds who have opposed this most vocally. The U.S. Appeals Court dismissed their objections as well late last week. However, today, the Supreme Court of the U.S. issued a stay on the sale. This stay puts everything on hold until further notice.
My reading of the Gonzalez opinion initially leads me to believe that the sale will go through. I am not a lawyer, so I have no expertise. However, my understanding of the 363 sale allows for the purchasing entity, the New Chrysler in this example, to pick and choose the terms of the sale. This is apparently legal provided that the negotiations are done in good faith (which has received objections from the Indiana Funds and others by claiming the sale was "sub rosa") and provides the best option available for all parties. Expert testimony which was not disputed in a timely manner indicated that the creditors receipt of 29 cents on the dollar would be better than what a liquidation would provide. Further, the court has determined that if the Fiat deal is not consummated, that liquidation is the only other option.
The Indiana Funds have also questioned the constitutionality of the U.S. Treasury using TARP funds to provide financing to Chrysler (both Old and New). This question may or may not be reviewed by the Supreme Court. Both the bankruptcy court and the appeals court have denied reviewing the question because they have determined that the Indiana Funds lack standing. This means that the use of TARP funds has not harmed them so they cannot challenge the action.
You can follow the progress with the Supreme Court at SCOTUS Blog.
Some very interesting analysis of dealer closures can be reviewed here.
This article is more about GM than Chrysler, but is relevant nonetheless. It is a rare occurrence where I tend to agree with Robert Reich.
For more history and context on one of the Indiana Funds, the Indiana State Teachers Retirement Fund, who is having its own issues, you can read the following: ISTA sues the state over school funding, the court's opinion, their website, and a report on the NEA taking over the ISTA.
Loose Ends... Vol. XLVI
Well, I've been researching the details of the Chrysler bankruptcy in my free time this week and still have not finished writing that article. It should be done tomorrow. Sorry for the delay for those of you waiting...
Given the hour, I'm not going to post much of anything of value here tonight. Here are a few things (without links) which I plan on looking into over the coming days: the GM bankruptcy, Obama's speech in Cairo, and the political climate in the U.K.
Given the hour, I'm not going to post much of anything of value here tonight. Here are a few things (without links) which I plan on looking into over the coming days: the GM bankruptcy, Obama's speech in Cairo, and the political climate in the U.K.
Monday, June 1, 2009
Capital Structure and Bankruptcy
The failure of the U.S. auto industry has been a dominant news story over the last few months. Today, GM filed for bankruptcy and it appears Chrysler will emerge reorganized soon after Judge Arthur Gonzalez rejected opposing arguments. Over a couple of articles, we will discuss some of the basic nuts and bolts of bankruptcy, a few of the key opponents of the Chrysler reorganization, and some general comments on the entire process.
Let's dive in.
One of our goals on this website is to provide education to our readers by explaining some of the background which is often glossed over in the mainstream media. In this article, we'll start by looking at the basic financial structure of a business. When a new business is started, it requires money. This money is referred to as capital and is used to fund business operations and get things going. Capital comes in two basic forms: debt and equity. The combination of debt and equity for a business is called its capital structure.
When an investor provides capital to a business, it comes in one of these two forms. Equity is a form of ownership often called stock. Equity investors become part owners (shareholders) in the firm. As shareholders, they have a claim on the earnings (profits) of the firm in the form of a dividend and have the ability to oversee the firm's operations via the board of directors. Note that if the company does not make any money, then the shareholders will probably not get paid.
Debt is the other form of capital. Debt investors are referred to as creditors - they are essentially lenders to the firm. Creditors have no claim on earnings and no say in the operations of the business. Creditors simply receive an interest payment on their loan; loans which can be traded in the market are called bonds. These creditors are then also called bondholders.
All of the above actually applies to both investors to new companies as well as existing companies. We'll create a fictitious example using a new company. Let's say that we're going to start a business and need $1M to get started. We're able to find some brave risk takers who are willing to take an equity stake in the company for a combined $400k. This will be represented by 4,000 shares at $100 each. The remaining $600k will be funded by bonds (debt). In this example, consider three classes of bond investors - each a little more risk averse than the other. The first $200k goes to the riskiest bonds. They pay a 12% interest rate are not backed by any sort of collateral. This is referred to as unsecured debt. The other $400k comes from bonds issued with a 6% interest rate and a 5% interest rate ($200k each) and are collateralized (secured) by assets the our new business is purchasing such as land and equipment. The difference between the 6% and 5% bonds are that the 5% bonds are "senior" to the 6% bonds.
After a while, our business is in trouble. If we get to the point where we cannot make interest payments to the bondholders, we may choose to file for bankruptcy protection. In some cases, a particular bondholder may force us into bankruptcy if we miss a payment. There are two key types of bankruptcies for businesses in the U.S. Chapter 11 is used for bankruptcy reorganization where the company attempts to strike deals with their creditors and emerge restructured. Chapter 7 is used to liquidate a company - i.e. sell off all the assets and cease to exist.
By the time our little business venture reaches Chapter 11, chances are most of our cash is gone. If we seek to reorganize, we must get our bondholders to agree to a deal. This deal would provide details of how we would reorganize our business to cut costs, raise cash, and/or renegotiate debt. The bankruptcy court has the authority to approve the plan, but the creditors (who invested $600k in our example) would have a major voice in the matter. In many cases, existing shareholders are "wiped out" - their shares are worthless. Also, there may be a debt-for-equity swap, where bondholders are willing to accept newly issued stock in lieu of their existing bonds which pay interest. Since the 5% yield bonds were senior and secured, those bondholders would generally be entitled to the best deal in the restructuring.
If no deal can be reached in Chapter 11, we would be liquidated in Chapter 7. You may hear of bondholders taking a "haircut" or receiving "25 cents on the dollar". If a bondholder gets paid in a restructuring or liquidation, they will not receive full value on their investment. This is called a haircut. If our unsecured bondholders took a haircut and 25 cents, that would mean they would be paid 25% of their original investment of $200k - in this example, $50k.
Ok. So, this article focused on basic education in corporate finance and bankruptcy. Sometime later this week, we'll dig deeper into the Chrysler bankruptcy and apply what we've learned here.
Let's dive in.
One of our goals on this website is to provide education to our readers by explaining some of the background which is often glossed over in the mainstream media. In this article, we'll start by looking at the basic financial structure of a business. When a new business is started, it requires money. This money is referred to as capital and is used to fund business operations and get things going. Capital comes in two basic forms: debt and equity. The combination of debt and equity for a business is called its capital structure.
When an investor provides capital to a business, it comes in one of these two forms. Equity is a form of ownership often called stock. Equity investors become part owners (shareholders) in the firm. As shareholders, they have a claim on the earnings (profits) of the firm in the form of a dividend and have the ability to oversee the firm's operations via the board of directors. Note that if the company does not make any money, then the shareholders will probably not get paid.
Debt is the other form of capital. Debt investors are referred to as creditors - they are essentially lenders to the firm. Creditors have no claim on earnings and no say in the operations of the business. Creditors simply receive an interest payment on their loan; loans which can be traded in the market are called bonds. These creditors are then also called bondholders.
All of the above actually applies to both investors to new companies as well as existing companies. We'll create a fictitious example using a new company. Let's say that we're going to start a business and need $1M to get started. We're able to find some brave risk takers who are willing to take an equity stake in the company for a combined $400k. This will be represented by 4,000 shares at $100 each. The remaining $600k will be funded by bonds (debt). In this example, consider three classes of bond investors - each a little more risk averse than the other. The first $200k goes to the riskiest bonds. They pay a 12% interest rate are not backed by any sort of collateral. This is referred to as unsecured debt. The other $400k comes from bonds issued with a 6% interest rate and a 5% interest rate ($200k each) and are collateralized (secured) by assets the our new business is purchasing such as land and equipment. The difference between the 6% and 5% bonds are that the 5% bonds are "senior" to the 6% bonds.
After a while, our business is in trouble. If we get to the point where we cannot make interest payments to the bondholders, we may choose to file for bankruptcy protection. In some cases, a particular bondholder may force us into bankruptcy if we miss a payment. There are two key types of bankruptcies for businesses in the U.S. Chapter 11 is used for bankruptcy reorganization where the company attempts to strike deals with their creditors and emerge restructured. Chapter 7 is used to liquidate a company - i.e. sell off all the assets and cease to exist.
By the time our little business venture reaches Chapter 11, chances are most of our cash is gone. If we seek to reorganize, we must get our bondholders to agree to a deal. This deal would provide details of how we would reorganize our business to cut costs, raise cash, and/or renegotiate debt. The bankruptcy court has the authority to approve the plan, but the creditors (who invested $600k in our example) would have a major voice in the matter. In many cases, existing shareholders are "wiped out" - their shares are worthless. Also, there may be a debt-for-equity swap, where bondholders are willing to accept newly issued stock in lieu of their existing bonds which pay interest. Since the 5% yield bonds were senior and secured, those bondholders would generally be entitled to the best deal in the restructuring.
If no deal can be reached in Chapter 11, we would be liquidated in Chapter 7. You may hear of bondholders taking a "haircut" or receiving "25 cents on the dollar". If a bondholder gets paid in a restructuring or liquidation, they will not receive full value on their investment. This is called a haircut. If our unsecured bondholders took a haircut and 25 cents, that would mean they would be paid 25% of their original investment of $200k - in this example, $50k.
Ok. So, this article focused on basic education in corporate finance and bankruptcy. Sometime later this week, we'll dig deeper into the Chrysler bankruptcy and apply what we've learned here.
Subscribe to:
Posts (Atom)