Bad-Mouthing Seniors

The odd story of Chrysler's Committee of Non-TARP Lenders came to an abrupt end last week. What began as a distressed debt investment turned into a public debate for which one side was not well prepared. The Non-TARP Lender group was composed of hedge funds executing a well-established distressed debt investment strategy. Section 510 of the bankruptcy code makes debt subordination agreements generally enforceable in bankruptcy. Thus, senior debt-holders, unlike most other investors, are almost always made whole when a company goes bankrupt. Buying the senior debt of a company in financial trouble is, in some ways, a bet that the company will go bankrupt.

70% of Chrysler's senior debt was held by banks, but 30% was acquired by hedge funds at a discount (according to Bloomberg) of between 50 and 70 cents on the dollar. Once the bankruptcy filing was made, debt-holders were offered something like 20 cents on the dollar. The funds didn't like the offer and negotiations stalemated.

In the pre-bailout world, Chrylser would probably have caved because the senior debt-holders had the law on their side. But this was only kinda about the law - the President held a press conference and chastised the Non-TARP Lenders for trying to profit at a time when everyone needed to make sacrifices. Thus, a tried-and-true investment strategy became a public relations apocalypse. The funds knocked each other down to get out and the Non-TARP Lenders group collapsed.