Chrysler, Hedge Funds and Contracts

President Obama is beginning to look less like Franklin Delano Roosevelt, and a lot like his distance cousin Teddy. After several months of trying to come up with a viable solution for preserving Chrysler, yesterday the ailing car company went into formal bankruptcy, which means that the auto unions and the government at this stage essentially now own the company.

For the last week, Obama has been working with all of the major parties - automaker Fiat, unions, banks, hedge funds and similar investors and lien holders on the company, to try to stave off bankruptcy, while trying to keep from adding even more federal loans to the beleaguered company. In the end, while most parties agreed, the major hedge funds balked, demanding preferential treatment in terms of payback and seeking to get 2-3 times as much return on their investments as every other players. Obama finally lost his patience, ordered the company into bankruptcy, and effectively hit the reset button, wiping out several billions of dollars of equity outstanding as part of the process.

No doubt the financial industry and its captive press will scream bloody murder here, but the events of the last week represent the emergence of a new, big-money hostile political environment that will likely only strengthen from here.

In financial circles, one of the most sacrosanct documents is the contract. Filled with obscure legalize, most contracts are dense, deliberately obscure, and are often designed to seek the maximum possible advantage of one side over the other. Contractual obligations have played a major part in the most recent financial crisis, especially when such contractual obligations have overwhelmingly benefited the financial industry. A prime example of this was the defense given by investment banks that, even while being funded to the tune of hundreds of billions of dollars by the US government, paid out lavish bonuses to superstar investment bankers, analysts and C-level officers - they were contractually obligated to pay these bonuses, and as such couldn't go back on them.

Contracts are important. However, the problem with contracts is that while they may in fact describe the contractual obligations between two parties, there is *always* a third party involved. Call it the public good, call it government, call it society, but in all cases it should be seen as the interest that the rest of society has in insuring the peace and stability of that society. One of the underlying concepts that has taken place over the last forty years has been the rise of the doctrine of private business - that so long as companies do not in fact engage in specifically illegal activity by the letter of the law, government has no role in the contractual process - even if the companies engage in activity that violates the spirit of the law. Grover Norquist's famous quip about wanting to see government so small that it can be drowned in a bathtub is perhaps the most pithy encapsulations of this philosophy.

Tim Geithner, a former Federal Reserve regional governor, and Ben Bernanke, the current Federal Reserve chairman, have been steeped in this zeitgeist for so long that it is central to their world view. Barack Obama, on the other hand, has seen what happens when the rule of contract exceeds the rule of law, and as he becomes more comfortable with his own authority, is also beginning to exercise what may very well become known as the Obama Doctrine - that contracts that harm the public good even while being within the letter of the law can be abrogated by the third party in those discussions - the government, keeper of the public good.

There are many in the investment community (and in political circles) who are fearful that this approach will cause investors to not want to reinvest in the banks, for fear of their investments essentially being annulled. This has always been powerful weapon to wield against those who would seek to change the status quo; however, it is an argument increasingly without teeth. Those who invest should understand implicitly that no investment is guaranteed to be without risk, regardless of whether that investment is a few shares of penny stock or a sizable investment in a car company ... or a bank. The owners of a business who fail to press the people who manage that business to be more responsible, more innovative, more willing to respond to changes in demand, and more ethically responsible should hardly be upset when those companies fail.

Indeed, this is perhaps one of the fundamental problems that this society faces: there is an implicit assumption that one can make a business grow and thrive simply by pouring money into it, especially at the senior management levels. In essence, money is being used as a way to get reward - dividends - without otherwise having to do any work. It also has become a way of dodging the responsibility of managing that company well; rather than planning for changing environments, trying to produce better products and services, most senior managers have become adept at manipulating the markets instead to increase dividend yields for their owners.

It's increasingly obvious that sweat equity, which has long been a very secondary aspect of business, is once again coming into its own. To me Obama has just turned Chrysler into an object lesson, one that banks and financial institutions in general should pay a great deal to. It looks like the silent partner is beginning to speak up, and what he's saying is going to completely reshape the way that America does business.