The Little Pension Funds That Could?

Those following the Chrysler bankruptcy know that the final holdouts are a set of Indiana pension funds, who have appealed the bankruptcy judge’s approval of the restructuring plan, attempting to force the company to explore other alternatives under a trustee who is independent of the government. They were lustily cheered on by The Wall Street Journal, elated to find good sturdy workingmen and -women willing to stand up to the Obama Administration and its “disdain for legal contracts,” and who could not be dismissed as speculators.

Well.

The pension funds in question bought the Chrysler debt in question last July for 43 cents on the dollar. (They stand to get 29 cents on the dollar in the restructuring.) I guess the difference between that and speculation is that “speculation” is something that bad people do; when pension funds by distressed debt, it’s called “investment.” I have no problem with pension funds buying modest amounts of risky investments, but they are taking the same risks that hedge funds are taking, and if they lose money on bad investments, that’s the fault of the pension fund managers.

Now, the popular defense of the Indiana pension funds is that they have a fiduciary duty to their beneficiaries to maximize the value of their assets. (Hedge funds should have the same duty to their limited partners, unless I’m missing something, but let’s set that aside.)  There is a deal on the table worth 29 cents on the dollar. Apparently they think Chrysler can do better by finding a a higher bidder (not likely at this point), or they can get more in liquidation. But that is far from a certainty, and the value of Chrysler is deteriorating as time passes; and if they manage to drag this out past June 15, Fiat can back out of the deal. So it’s not at all clear that their actions have a positive expected value for their beneficiaries.

Their cheerleaders, like the Journal, think that the little pension funds are standing up to the big evil government and defending the rule of law – namely, the order of priority of creditors in bankruptcy. (The issue is the relative treatment of the UAW and the bondholders.) But that’s not the job of a fiduciary; a fiduciary isn’t supposed to stand on legal principles and win Pyrrhic victories that harm the people it is supposed to serve.

Indiana Treasurer Richard Mourdock claims:

This is about the law, the law, the law. This is an unprecedented action to say that secured creditors can have their rights stripped away. We think it`s clearly illegal. As a fiduciary, I had no choice but to act.

The fiduciary duty is to get the most for the beneficiaries, not to enforce the law; Mourdock’s “no choice” language is pure bravado, especially when the law is as unclear as it is.

Steve Jakubowski wrote the most in-depth analysis I’ve seen. In short, there is a tension between the competing principles of (1) following the order of priority and (2) the “fresh start” policy of Chapter 11. There is a question of whether the Chrysler plan is an asset sale or a surreptitious reorganization. And there is also a question of whether it is more important to follow the order of priority or to get the most for the secured creditors. In that case, those might not imply the same outcome, since some of the key parties, including the government and Fiat, are free to walk away from the deal instead of giving the secured creditors a bigger share of it; that would lead to liquidation, which may be even worse for the secured creditors. (That was the conclusion of all the other secured creditors, although granted many had their arms twisted by the government.) Jakubowski says that the pension funds have a reasonable legal argument – perhaps a better one than Chrysler – but it’s by no means an easy case. And from a financial standpoint, they could still be shooting themselves in the foot.

Joe Donnelly, a Democratic Indiana congressman, is opposing Mourdock, saying that the action is likely to leave the pension funds worse off than the restructuring plan, and in addition threatens thousands of Chrysler jobs in Indiana (many in his district).

So what’s going on here? Either Mourdock really thinks that the chances of getting more than 29 cents outweigh the very real risk of getting less (and of blowing up Chrysler in the process). Or Mourdock (and Mitch Daniels, the Republican governor of Indiana?) believes that the order of priority of creditors in bankruptcy is more important than maximizing value for their retirees. Or Mourdock is trying to shift the blame for losing pension fund money on distressed Chrysler debt. Or he wants to score political points and embarrass President Obama.

In politics, anything is possible.

Update: If you care about this issue, you should read Steve Jakubowski’s latest.

By James Kwak

29 responses to “The Little Pension Funds That Could?

  1. Old Lady in Red

    As someone whose $50K Chrysler bond, bought in 1999
    for 100 cents on the dollar and which is slated to
    mature 9/1/09 (hahahaha), and now represents about
    25 per cent of my seriously trashed IRA account, I
    wish them well.

    I bought that bond because I was told it was safe, solid….

    That Goldman Sachs et al sold off their bonds for pennies knowing that they were in no position to negotiate at this time has nothing to do with the
    responsibilities to make me whole.

  2. Chrysler is already blown up. What remains to be seen is whether the pieces can be glued togther to resemble something with tangible future value. I have no problem with recalcitrant bondholders, regardless of what they paid for their bonds. On the other hand I find the strongarm charges risible. This isn’t a tennis match. In the end it is about the law, if any one cares to enforce it. There’s already been much skirting of laws and much very poorly informed ad hoc legislation since the wheels started coming off.

  3. Whatever happened to the prudent investor standard?

    As far as I can see the primary obligation of pension funds is preservation of capital with yield considerations to be based within that context.

    Buying distressed bonds would never be allowed under this standard. I just don’t understand the motivation of these fund managers. This is a state function, not a private enterprise and the participants don’t have the option of shopping their IRA’s around.

    Just another example of the perversion of ethical standards that seems to exist at every level of commerce these days.

  4. So if:

    (a) Someone is trying to screw you over, and
    (b) They appear likely to succeed, then

    (c) Your fiduciary duty is to let them?

    Whether or not this is happening here, it is a logical consequence of your argument.

    The question of whether they would receive more in liquidation is absolutely crucial and makes all the difference.

    If I ran a fund (I do not), believed that the Administration’s actions are illegal (I do), and believed that I could receive more in liquidation (I don’t know), then I think my fiduciary duty would be to exercise every legal route trying to find an appeals court judge willing to interpret the law consistent with its plain meaning. And I am pretty sure the phrase “broader policy objectives” does not appear in the bankruptcy code.

  5. One conclusion is that Mr. Mourdoch is desperate and embarrassed and is willing to spend a great sum of other peoples money on legal fees in the hope that this effort is successfully perceived as a genuine attempt at carrying out his public responsibility.

    Also, it should be clear to all that the Indiana Governor, Mitch Daniels, has no particular interest in the welfare of retirees or working men and women.

    A short explanation is in order. Immediately before the sale of the Indianapolis Power and Light Company (IPALCO) to America Electric Power (AEP) the director of IPALCO (the same Mr. Daniels) was busy selling his financial interest in the company at the same time telling rank and file employees that they should purchase IPALCO stock for their retirement. The employees that took Mitch Daniels advice lost much of their retirement savings as stock prices for AEP plummeted shortly after the sale of IPALCO to AEP. Allegations of insider trading were so strong that Mr. Daniels abruptly resigned as the Budget Director for Bush 43.

    Also, one of Mr. Daniels first acts as Governor of Indiana was to suspend recognition of Indiana public employees representation.

  6. I think the most important issue is whether you could get more in liquidation. But you also have to consider risk. You are walking away from a sure 29 cents to pursue some riskier higher number – which is certainly not $1. If you really believe that your highest risk-adjusted expected return is in liquidation, then your duty is to do what Mourdock is doing, and attempt to block the restructuring as illegal. That’s why I listed it as one of the possible motivations.

    But 98% of the bondholders (weighted by holdings) decided to take the sure 29 cents. I acknowledge there was some arm-twisting there. But there may also have been some rational calculation as well – even if a bank thought 29 cents was the rational choice, it would still complain about government pressure. And all those hedge funds also had fiduciary duties to their limited partners.

    So why, then, is the Treasurer of Indiana – probably not the most sophisticated investor in the mix here – the only person who thinks that liquidation is the right choice?

  7. How about the issue that if the government can strip contract law for this deal they can do it for all deals? The Indiana pension funds are not only fighting to protect their rights for this specific deal, but ultimately for ALL deals in their portfolio. Even if they come away with zero return on this deal, if they have protected their rights on all of their other holdings it will have been worth it. And we can then get down on our knees and thank them profusely for fighting for one of the main underpinnings of capitalism – contract law.

  8. bobgreenfest

    Clearly the theory of relativity – what goes up must come down, doesn’t apply to investment managers when they make bad decisions. See http://www.bobgreenfest.wordpress.com for additional insights.

  9. winstongator

    There is NO way they would get more in liquidation. Was the govt’s capital injection to Chrysler strong-arming? How about the renegotiation with the unions? With the government intervention, this is obviously not a normal restructuring.

    Assume Mourdock was successful, Chrysler was liquidated, and he got $0.10/$1. Should he be sued for pursuing a political goal instead of looking after the best interests of the pension fund?

    Assume the deal doesn’t go through, in 3 months do you think Fiat will pay more or less for their share?

  10. James Kwak: “If you really believe that your highest risk-adjusted expected return is in liquidation, then your duty is to do what Mourdock is doing, and attempt to block the restructuring as illegal.”

    Is it really? Expected value is a single number, which does not reflect the spectrum of risk. IMO, it is a thin reed upon which to base a fiduciary decision.

  11. It is not a fiduciary duty “to get the most for the beneficiaries, not to enforce the law”

    A fiduciary duty is an obligation to act in the best interest of the beneficiaries.

    Most likely, the pension fund owns other corporate bonds.

    It is not difficult to see how this legal fight is a fight to preserve the value of other corporate bonds. If anything, a failure to challenge the government seems to be the breach of fiduciary duty.

    If the Indiana pension fund trustees win, all their corporate bond holdings will increase in value.

  12. The bondholders clearly knew what they were getting into. They acquired these bonds in July of last year, and then held on to them, perhaps assuming that the government would not let a bankruptcy occur. They gambled and lost, and I have no sympathy for them.

    But really, I agree that the question for Mourdock is whether he can win, regardless of whether that will maximize the return on these particular bonds. As Milton Recht just pointed out, it’s likely that there are larger portfolio considerations, and the fact that 98% of the other bondholders reached a different conclusion is irrelevant. As James pointed out, there was obviously some arm twisting, and furthermore, larger bondholders likely have political motivations that the smallers ones don’t.

    On the issue of whether they can win the case, the Jakubowski piece is pretty informative. He quotes the Second Circuit Court:

    “Thus, whether a particular settlement’s distribution scheme complies with the Code’s priority scheme must be the most important factor for the bankruptcy court to consider when determining whether a settlement is “fair and equitable” under Rule 9019. The court must be certain that parties to a settlement have not employed a settlement as a means to avoid the priority strictures of the Bankruptcy Code.

    In the Chapter 11 context, whether a settlement’s distribution plan complies with the Bankruptcy Code’s priority scheme will often be the dispositive factor. However, where the remaining factors weigh heavily in favor of approving a settlement, the bankruptcy court, in its discretion, could endorse a settlement that does not comply in some minor respects with the priority rule if the parties to the settlement justify, and the reviewing court clearly articulates the reasons for approving, a settlement that deviates from the priority rule. ”

    The first paragraph would seem to proscribe exactly the sort of thing the government is trying to do. The government is clearly trying to circumvent the priority strictures of the bankruptcy code through a pre-bankruptcy settlement.

    But the next paragraph basically say that they can do this if the issues are minor, and the court can show good reason for ignoring them.

    If the court considers the Indiana pension funds to be a minor issue, (possible), and the reason for ignoring them to be good (highly likely), then they will lose their challenge. You can make your own assessment of the valuation of the bonds in this environment.

    A couple of other points. While it may be true that a successful challenge here will increase the value of other bonds in Mourdock’s portfolio, it’s also possible that losing the challenge will negatively affect them, by setting a different sort of precedent. He really might want to sit this one out.

    Also, what is most likely to happen is that the political pressure will be too great and he will find a reason to end his hold-out. I have a hard time believing that the powers that be will let Mr. Mourdock derail this process.

  13. Don’t you find it interesting that Mourdock thinks he is more qualified to put a value on Chrysler than JP Morgan or any of the other professional underwriters?

    I’d say that if he succeeds in getting a liquidation of Chrysler and gets less than 29 cents, he’s guaranteed a lawsuit. For this reason, no matter how the courts rule I expect him to back down before June 15.

  14. The strong arming was the (alleged) threats to unleash the auditors and regulators on those who did not comply with the gov’t, not handing over cash to Chrysler.

  15. Speculation is intrinsicaly neither bad nor good, it simply is. Is it somehow morally wrong to provide a discounted value for distressed assets? Or do we want our investors to all overpay with gargantuan leverage a la the private equity funds of 2007? I would argue these entities did much more harm to the so-called “public good” than any vulture funds ever will.

  16. What is missing is the size of the C investment relative to the total pool of investable assets. Some diversification is a necessity, in fact, depending on the size of the pool, if they had no exposure to “risky” assets you could say they were violating their fiduciary standard.

  17. “I think the most important issue is whether you could get more in liquidation.”

    NO, the most important issue is how you negotiate to get the highest possible return. You do that by threatening, cajoling, acting irrational, whatever it takes.

    As in mediation, it is not what is fair, it is what the parties agree to. Kudos to the bond holders for being as difficult as they can be.

  18. Generally pension funds should invest in “investment” grade instruments. Typically this means A rated or better.

    A non-profit like TIAA (Teacher’s Insurance) allows participants to allocate contributions to different funds that they manage. The most conservative is basically a bond fund. They also pioneered a stock fund in the 1950’s. This gives participants the option of setting their own threshold for “risk”.

    In the case under discussion the public employees don’t have this sort of control, therefore one would think that the balance would tilt towards safety. Those who wanted to take on addition risk could avail themselves of IRA’s or other supplementary plans.

    I still think the trustees were irresponsible and are trying to lay the blame elsewhere. As the scandals with the similar fund in NY continues to unfold it would be wise to “follow the money”. There were a whole bevy of intermediates getting fees for advice and lobbying the fund managers to invest in selected areas.

  19. I beg to differ. If employees do not have control over the investments it is the responsibility of the managers to, among other things, match the investment horizon with the estimated call on the investment funds.

    If you invested the assets only in “safe” instruments – I assume you mean bond funds and the like – then the pool would run the very real risk of having inflation outstrip it’s value, since some significant portion of the liabilities would be long term (younger employees decades away from retirement).

    The NY situation, while ugly, has no relevance here.

  20. What if liquidation were not the only alternative?

    Given all that the UAW has to lose in liquidation, a case could be made that they could be persuaded to give up some of their equity to the dissident secured creditors in order to keep the deal moving forward.

    As Fiat’s contribution to the New Chrysler is their technology and know-how in building small fuel efficient cars, its also likely that they would proceed even if the deal were somewhat less favorable as their is no other alternative way for them to gain such an inexpensive entry to the US market. As such, if necessary to get the deal done, Fiat is unlikely to walk.

    As for the US, liquidation would transfer the UAW’s pension and older retiree health care obligations to the pension benefit guarantee fund and to Medicare. It would also mean even more lost jobs, and other costs to state and federal governments. One should not rule out some flexibility by the US as a result.

    Thus, the secured creditors strategy to delay the Bankruptcy process could well result in a renegotiation of the deal structure that could lead the dissident secured creditors gaining either a larger cash payout or an equity enhancement, thereby improving their position.

    Furthermore, as the deal appears to be proceeding without resolving this issue, there does not appear to be much downside for the dissident secured creditors. If they lose, they will get 29 cents on the dollar but if they succeed with their appeals they could get more as long as the New Chrysler emerges as a successful company with the means to pay their judgment.

  21. Buying in July 07 was basically buying at the peak. Why you would make that bet – or why you would let yourself be sold – is a question in and of itself.

    It has to be political CYA. It’s a good story of the little guy fighting the Washington man, but what a horrible trade.

  22. Make that July 08.

  23. Mr. Mourdock says this is about law. Is he picking and choosing when we follow the law and when we ignore it? There are many who feel that the government should not have propped up the banks nor the car manufacturers which I guess is entirely ‘markets free of government intervention’. The “too big to fail” banks, would have been treated just like smaller banks and GM and Chrysler would have been in bankruptcy months ago potentially.

    Am I correct in assuming that had the country been most lawful, read less hypocritical as in the advice that we’ve given out over the years to other governments assisting their banks and corporations, and not intervened at all, wouldn’t the Chrysler assets have been worth far less in liquidation or on bid?

    My reasoning is that minus the government intervention, there would be far more assets potentially up for sale CONCURRENTLY, from banks and insurers, as well as car companies and their suppliers. Whether or not ‘no intervention’ would have been cataclysmic, hasn’t the intervention of the government so far, positively contributed to the amount the Indiana Pension fund THINKS they could get versus no intervention and liquidations everywhere?

  24. I’m glad to see someone taking a stand against the USG’s clear trashing of well-established collateral priorities. It is reprehensible for the USG to dictate solutions outside of these priorities. The US Government is not supposed to have hyper-legal powers, especially not to hand out political rewards to unions (or to anyone else).

    From a practical standpoint, however, this probably is the best deal the Indiana Pension Fund is going to get. But that should be its choice, not a mandate from the USG.

  25. Bob Green Wrote:

    Clearly the theory of relativity – what goes up must come down, doesn’t apply to investment managers when they make bad decisions. See http://www.bobgreenfest.wordpress.com for additional insights.

    Bob, if you think that the theory of relativity is “what goes up, must come down” then I have to question the value of any of your additional “insights”.

  26. There is another possibility besides letting the deal close as is or delaying the close of and allowing the bondholders to get more than 29 cents on the dollar.

    The bondholders need to show irreparable harm to get the deal delayed, but when money is involved there rarely is irreparable harm if there is somebody to sue for money damages later.

    Justice Ginsburg, or the whole Supreme Ct, can find that there is not irreparable harm, and it can allow the Fiat deal to close as is. Simultaneously, the Supreme Ct. can say with that denial that the bondholders have the right to sue the US Gov’t and the UAW for the loss of value due to not following bankruptcy priority. The Supreme Ct would have to find some way to limit the lawsuit as much as possible to the peculiar situation, such as when the government ends up with a controlling interest in the post bankrupt company.

    It would be a win-win for all parties. The deal closes. Fiat gets Chrysler. The government and the UAW get what they want and the secured bondholders get their day in court to prove they are entitled to more money. If the bondholders win, the payout would come from the funds for US lawsuits and not from Chrysler or Fiat.

  27. Doh! Tyler Durden just bashed this post over on zero hedge. I’d like to think my two favorite blogs were on the same page, but oh well. Hopefully James will respond to the critique.

  28. James:

    Get your facts straight. Some arm twisting? The original dissedent group called themselves the “non-Tarp lenders.” Then Perella Weinberg was “directly threatened” by Auto task force (recall the national headlines that Lauria made when he told of this threat to a Detroit radio station). Then one by one the non-Tarp lenders caved after their liveihood was threatened by Rattner.

    One of the big TARP lendsers was JP Morgan. Jamie Dimon has called this a bad deal for the senior creditors. So, why did they argree/ THey had no choice.

    Your 29 cents number is what the Governemnt says it is worth in liquidation. THe non-tarp lenders thought it was worth 45 to 50 cents in liquidation.

    Why don’t you do some real analysis instead of warmed over superficial political analysis. If that is too hard, then just palguize someone who does. Its good enough for Marureen Dowd.

  29. Miss Red, Did you happen to walk by a Chrysler dealership in 1999 (when you bought those bonds) and test drive any of the cars Chrysler was turning out at that time??? I wouldn’t want to put 25% of my retirement money in any corporation turning out products like that. Toyota or Honda bonds might have been a better gamble. But don’t worry, the June 6th Issue of “The Economist” magazine has cover art depicting a new hybrid car Chrysler is working on. Take a look!!!