The Hedge Fund Empire Strikes Back

The role of hedge funds in the bankruptcy of Chrysler and GM will probably be discussed and studied for some time.  It’s not often this POTUS singles out a Financial Institution for scorn since they’ve all been major donors to his campaign but POTUS made an exception when announcing the Chrysler bankruptcy.  Evidently, POTUS was not amused that a few of them would not bend to his will on the deal.

The most interesting thing is that the spoilers are now responding.  They are not only responding, they are making it clear that the group the cut the deal were TARP fund babies and they were not.  They are actively referring themselves as the No-Tarp Gang just to make that perfectly clear.

Also, interesting is the tone of the coverage concerning the bankruptcy.   A Motor Trend blog has a headline screaming  Chrysler Bankruptcy “Cruel” Result of Hedge Fund Greediness. Motor Trend obviously has more interest in the Car Makers than the Deal Makers and there in lies the rub.  The government-brokered deal, led by four of the biggest Tarp Babies, puts interests that are usually at the back of the line in corporate bankruptcy at the front.  Basically the union employees could potentially lose it all in the bankruptcy court.

This deal, turns the entire idea of the safety and primacy of bonds in a bankruptcy deal upside down which could argueably further destabilize financial markets. So, before you accuse me of being anti-union here, which I’m not, let me talk about that.   Bonds are usually first in line in any bankruptcy.  It’s why they are considered less risky and yield less than their riskier cousins, the equities.  Folks that buy corporate bonds play an important role in the market.  They provide corporations with huge, long term sources of cash at better terms than any one of them could get from a bank.

If a deal can be cut that undercuts the nature of bonds, what would this mean to other bond holders in other deals that are likely in the bankruptcy pipe?  (This would include GM and other industries.) Could this deal actually destabilize the primacy of bonds in the bankruptcy hierarchy?  Is that what the fuss is about?   Are they being greedy?  Are they looking out for their investors?  Are they posturing?  I don’t think we quite know yet. But, the Hedge Funds spoke up as reported in today’s WAPO.

President Obama’s harsh attack on hedge funds he blamed for forcing Chrysler into bankruptcy yesterday sparked cries of protest from the secretive financial firms that hold about $1 billion of the automaker’s debt.

Hedge funds and investment managers were irate at Obama’s description of them as “speculators” who were “refusing to sacrifice like everyone else” and who wanted “to hold out for the prospect of an unjustified taxpayer-funded bailout.”

“Some of the characterizations that were used today to refer to us as speculators or to say we’re looking for a bailout is really unfair,” said one executive who spoke on condition of anonymity because of the sensitivity of the matter. “What we’re looking for is a reasonable payout on the value of the debt . . . more in line with what unions and Fiat were getting.”

George Schultze, the managing member of the hedge fund Schultze Asset Management, a Chrysler bondholder, said, “We are simply seeking to enforce our bargained-for rights under well-settled law.”

“Hopefully, the bankruptcy process will help refocus on this issue rather than on pointing fingers at lenders,” he said.

I supposed that I don’t have to tell you that hedge funds are not charitable organizations but many of them actually invest for charitable organizations, along with unions and state and government workers.  Their clientele can be anything from a small group of rich investors, to  you and me, actually. We’ve heard a lot about them recently but most people, I’d speculate, don’t know a lot about what they are and what they do.  Hedge funds came onto the scene in the 1950s and what mostly defines them is their regulation regime.

Here’s an easy definition from a website at the University of Iowa.

“Hedge fund” is a general, non-legal term that was originally used to describe a type of private and unregistered investment pool that employed sophisticated hedging and arbitrage techniques to trade in the corporate equity markets. Hedge funds have traditionally been limited to sophisticated, wealthy investors. Over time, the activities of hedge funds broadened into other financial instruments and activities. Today, the term “hedge fund” refers not so much to hedging techniques, which hedge funds may or may not employ, as it does to their status as private and unregistered investment pools.

Hedge funds are similar to mutual funds in that they both are pooled investment vehicles that accept investors’ money and generally invest it on a collective basis. However, they are regulated in significantly different ways. Up until 2005, hedge funds in the United States often relied on Section 4(2) and Rule 506 of Regulation D of the Securities Act of 1933 to avoid having to register their securities with the Securities and Exchange Commission of the United States (SEC).  Further, to avoid regulation regarding mutual funds (a type of “investment company”), hedge funds relied on Sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940. In short, hedge funds escaped most U.S. regulation directed at other investment vehicles such as mutual funds.

European nations regulate hedge funds by either regulating the type of investor who can invest in a hedge fund or by regulating the minimum subscription level required to invest in a hedge fund. In the years to come, experts are predicting the rise of an alternative regulatory framework that will be tiered yet flexible.

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