Financial reform or sneaky Wall Street bailout?

When the government took over General Motors and Chrysler last year under a bastardized form of bankruptcy, the "secured" creditors were forced to accept pennies on the dollar in order to protect the unsecured interests of the United Auto Workers.  Michael Barone wrote about the travesty in The Washington Examiner:

Last Friday, the day after Chrysler filed for bankruptcy, I drove past the company’s headquarters on Interstate 75 in Auburn Hills, Mich.

As I glanced at the pentagram logo I felt myself tearing up a little bit. Anyone who grew up in the Detroit area, as I did, can’t help but be sad to see a once great company fail.

But my sadness turned to anger later when I heard what bankruptcy lawyer Tom Lauria said on a WJR talk show that morning. “One of my clients,” Lauria told host Frank Beckmann, “was directly threatened by the White House and in essence compelled to withdraw its opposition to the deal under threat that the full force of the White House press corps would destroy its reputation if it continued to fight.”

Lauria represented one of the bondholder firms, Perella Weinberg, which initially rejected the Obama deal that would give the bondholders about 33 cents on the dollar for their secured debts while giving the United Auto Workers retirees about 50 cents on the dollar for their unsecured debts.

This of course is a violation of one of the basic principles of bankruptcy law, which is that secured creditors — those who lended money only on the contractual promise that if the debt was unpaid they’d get specific property back — get paid off in full before unsecured creditors get anything. Perella Weinberg withdrew its objection to the settlement, but other bondholders did not, which triggered the bankruptcy filing.

After that came a denunciation of the objecting bondholders as “speculators” by Barack Obama in his news conference last Thursday. And then death threats to bondholders from parties unknown.

The White House denied that it strong-armed Perella Weinberg. The firm issued a statement saying it decided to accept the settlement, but it pointedly did not deny that it had been threatened by the White House. Which is to say, the threat worked.

Fast forward to the present and compare the treatment of the bondholders of GM and Chrysler with provisions in the financial reform legislation heading for a vote as early as next week in the Senate.  Brian Darling of the Heritage Foundation lays it out for Human Events:

There are two specific problems with the Senate approach to “reform.”

First, this legislation would create a new $50-billion bailout slush fund controlled by the Federal Deposit Insurance Corporation (FDIC). Very big banks and other “eligible financial companies” would be taxed by the FDIC to build up this fund. As with any tax, though, it’s consumers--you and me–who would eventually pay this levy.

The Obama Administration this weekend requested that the $50 billion pre-funded bailout money be removed from the bill. But according to Foxnews.com, Treasury Secretary Tim Geithner advocated last year that any bailout funding should be addressed post bailout through a tax on big Wall Street firms. If Senate Democrats only take out the $50 billion slush fund and leave the bailout authority intact, then the taxpayers will still be on the hook for any future bailouts.

Another problem with this bill is that it would bail out the creditors of companies and wouldn’t require any creditor to take a loss after a company starts to fail. If the bailout slush fund is tapped, the FDIC would have the power to reimburse creditors. That could allow the FDIC to pay creditors more than they invested (pursuant to Section 210 of the Dodd bill).

Think about that. If creditors know they aren’t likely take a loss, and risk has been eliminated from an investment, its taxpayers who are assuming all the risk. Of course, taxpayers get none of the rewards if the investments pay off–we would simply be on the hook if they fail. Taxpayers could expect no reward for having insured transactions and protected wealthy investors from any risk. The AIG bailout is a great example of this model.

I'm sure the bondholders of GM and Chrysler who lost their life savings and retirement will be interested to know why President Obama didn't see fit to protect them, calling them "speculators", but is now prepared to legislate future creditor protection for failing financial institutions through the "full faith and credit of the U.S. government" FDIC.

If left unchecked, the Obama administration will continue to use its regulatory agencies and the Congress to protect its friends and destroy its enemies.  I hope the Republicans will find the courage to filibuster this disastrous financial reform bill.

Update:  The Heritage Foundation has more on why this bill will harm consumers if it becomes law.