“Ghetto” is defined as;
a quarter of a city in which members of a minority group live especially because of social, legal, or economic pressure or a situation that resembles a ghetto especially in conferring inferior status or limiting opportunity <the pink-collar ghetto>
Whether by design or happenstance the actions of the Treasury, the Federal Reserve and other executive branches of the government have created “credit ghettos.” The unintended consequences of credit ghettos may take years to unfold, but the effect will be pernicious.
Government Guarantees and the Credit Ghetto
Both the Bush Administration and the Obama administration responded to the fall 2008 financial crisis through guaranteeing and backstopping financial institutions, government lending enterprises (FNMA, GNMA, etc), insurance companies (AIG), near financial institutions (GE, GM, Chrysler), money market funds and other entities. Neal Barofsky, special investigator for the Trouble Asset Relief Program (TARP), released a report in July 2009, detailing that there are now 50 government guaranty programs that potentially expose the taxpayer to a staggering 23.7 trillion dollars debt.
Thus, a giant bubble of protection has been placed over government-favored financial institutions. Those within this bubble can borrow money as low as .25% from the Federal Reserve and have virtually unlimited access to the credit markets. These favored lenders have been able to raise capital from depositors and equity and debt investors. Citicorp, one of the favored entities has watched its stock soar from under $1 dollar per share to over $5 per share, not because its business has improved measurably, but because of these backstops. Who wouldn’t want to lend to company where the full faith and credit of the US government is protecting the loan? The remainder of American business has been relegated to a “credit ghetto” where life is much more expensive.
Rewriting the Bankruptcy Code
Never leaving bad enough alone, the government also decided to try its hand at rewriting the bankruptcy code through executive fiat. In the Chrysler bankruptcy, senior creditors with contractual rights were pushed aside and the politically-favored, unsecured creditor unions were arbitrarily awarded 55% of the company. The senior creditors were offered 30-35 cents on the dollar for their debt. Former GE Chairman, Jack Welch succinctly put it, “The creditors’ rights were trashed and the unions got 55 percent of the company.”
Alas, unlike the world of politics, bad deeds get punished in the credit markets. The reaction was immediate and angry:
Fund Managers Burned by Obama Now Say They are Wary
May 20 (Bloomberg) — Hedge fund manager George Schultze says he may avoid lending to any more unionized companies after being burned by President Barack Obama in Chrysler LLC’s Fridson Investment Advisors have joined Schultze Asset Management LLC in saying lenders may be unwilling to back unionized companies with underfunded pension and medical obligations, such as airlines and auto-industry suppliers, because Chrysler’s creditors failed to block Obama’s move. The reluctance may put additional pressure on borrowers seeking capital in the worst financial crisis since the Great Depression.
“Lenders will have to figure out how to price this risk,” Schultze, 39, said in a telephone interview from his office in Purchase, New York. “The obvious one is: Don’t lend to a company with big legacy liabilities or demand a much higher rate of interest because you may be leapfrogged in a bankruptcy.”
Thus, another credit ghetto has been created: unionized companies with underfunded pension and retiree medical obligations.
Why We Should Care – The Unintended Consequences
Why should we care as this is just esoteric credit market maneuverings? We should care a lot. Credit is a company’s lifeblood. The government either intentionally or unintentionally is providing the “lifeblood” on favorable terms to the politically favored. It is creating a protected bubble where low cost borrowing takes place. Outside the bubble the government has created “credit ghettos.” First are non-union companies who can borrow at the “free market” rate. Second, are union companies that have been threatened with either no access to money or money at a penalty rate. In essence, any company outside the bubble is borrowing at a penalty rate. While banks can borrow from the Federal Reserve at close to a 0% interest rate, corporate borrowers (non-high yield) are borrowing on average of 4.5% for intermediate debt and 6.20% for long-term debt. (Source – WSJ)
It is obvious that those relegated to the “credit ghetto” are paying a penalty rate which flows through to net income and stock price. In truth it is a hidden tax on non-financial companies who did not get into trouble. The Federal Reserve has grossly distorted credit allocation to the detriment of these companies. Today, with the Federal Reserve showering credit on the markets, availability of credit for non-financial companies is not an issue – yet! Once the torrent slows to a trickle, the non-financial companies will be in a world of pain.
loading...
Related posts:
