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Are There Any Rules In The Bailout Game?
...But on the other hand, lots of things are not happening. Many investors are sitting on the sidelines, as is much money. Why? Because it is impossible to know what the rules of the game are. And that's because the administration and the Congress keep changing the rules in capricious ways in pursuit of larger political objectives....

...Investors, other than the banks who desperately needed TARP funds for survival, are leery of any program that uses them. Anyone who took TARP funds has been subject to government interference in managerial decisions. The restrictions on bonuses and executive pay have been widely discussed in the media. Less well known are restrictions on the banks' ability to hire foreigners, and the constant harassment by Congress over internal management decisions on everything from the use of private aircraft to the locations of conferences. Some of these concerns are well justified, of course, but it wasn't clear ex-ante what all of the rules were and it isn't clear ex-post either...

...The administration decided to tilt the restructuring in favor of the unions. The government proposed giving the United Auto Workers' retiree health fund a 55% equity stake in Chrysler--more than the combined stakes of Chrysler's merger partner, Fiat, or the other secured creditors that are owed roughly $7 billion. When some of the secured creditors, who were offered 30 cents on the dollar, balked, they were attacked by Obama as speculators.

Because of the holdout, Chrysler filed for Chapter 11 last week, and GM will soon follow. One might hope that, in bankruptcy, the well-known rules of the game, not political favoritism, would rule the day. Chrysler's dissident lenders have on their side the "absolute priority" bankruptcy rule, which holds that value must be distributed according to the legal priorities of the stakeholders.

Unfortunately, the bankruptcy code also holds that the absolute priority rule can be modified if a two-thirds majority can convince the court that it makes legal or business sense. Two-thirds of the lenders can force the holdouts to go along with them in a procedure called a cram-down.

That is exactly what is likely to happen. Citi, JP Morgan Chase, Goldman Sachs and Morgan Stanley, all major recipients of TARP Funds, all deep in the pocket of the Treasury, agreed to the administration's plan. So it looks like bankruptcy law will take a back seat to social policy....