Hoosiers vs. Crony Capitalism - How Indiana took on the federal bailout machine and restored the rule of law

Hoosiers vs. Crony Capitalism. By MITCH DANIELS
How my state took on the Obama bailout machine and restored the rule of law.WSJ, June 04, 2010

June 10 will be a silent anniversary, but one worth noting by those alarmed at the past year's assault on free institutions. It was last June 10 when the federal government tossed aside the option of proven, workable bankruptcy procedures in order to nationalize Chrysler on behalf of its union allies.

In order to provide preferential treatment to its cronies, the Obama administration confiscated the property of those creditors who had lent money to Chrysler in good faith, believing that their interest was legally secured and that they stood at the head of the line in the event of the auto company's failure.

The shock wave through the economic markets from this arbitrary redefinition of "secured creditors" rights was profound. Could centuries of crystal-clear law really be overthrown by executive fiat? Apparently, yes. The Supreme Court declined to intervene in the takeover. The cost of corporate borrowing was clearly headed upward as the U.S. for the first time imitated those Third World despotisms where economic rules can be changed without warning at the ruler's whim and convenience.

Equally profound was the message sent to the legal community, which quickly began to cite the "Chrysler precedent" as the now-acceptable judicial model for stripping secured creditors' rights in the name of expediency. Just days after the decision, the Phoenix Coyotes of the National Hockey League invoked the Chrysler case in an attempt to undermine secured creditors' rights and hasten bankruptcy.

Those brave few who protested the brute force taking of their money were attacked by administration apparatchiks for the sin of doing their fiduciary duty to their investors and shareholders. Calls went out from the White House, encouraging submission and warning of the consequences of opposition. One by one, potential plaintiffs surrendered.

The one effort to stop the Chrysler cramdown was launched by three Indiana pension funds. Believing they were making both a wise investment and a gesture supportive of a longtime state employer, Hoosier retired teachers and state policemen had purchased some $19 million in Chrysler's secured debt. The market consensus at the time was that, at 43 cents to par, the bonds were well below their value if bankruptcy ultimately came.

Bankruptcy came, all right, but in a new, extra-legal form run by the federal government. The United Auto Workers, who owned no interest in the company, were simply handed a 55% interest, a gift valued then at $4.5 billion. When no one else wanted to buy the firm, Fiat was given a 20% stake for free to take it over. After this looting, the legitimate creditors were told to be happy with the remnants. For Indiana's retired teachers and state policemen, this amounted to 29 cents on the dollar, a loss of $6 million versus the purchase price and millions more below the expected value in a standard Chapter 11 proceeding.

When, alone among the victims, Indiana retirees went to court, they caused a lot of discomfort but no change in the outcome. The Second District U.S. Court of Appeals declined to overturn the cramdown, but the judges refused to go within a mile of the merits. How could they? The law calls certain instruments "secured" credit for a reason, and there was absolutely zero precedent for the Chrysler confiscation.

In an article by Zach Lowe published last fall in the Am Law Daily and the American Lawyer magazine, UCLA Law School Prof. Lynn LoPucki said of the cramdown: "What happened . . . was so outrageous and illegal that until March of this year [2009], nobody even conceptualized it." The Second Circuit opinion, like the Supreme Court's refusal to stay the nationalization, went out of its way to state that the ruling did not reach the substantive issues raised.

Aided by incensed counsel donating much of their time pro bono, Indiana returned to the Supreme Court with a slim hope of recovering its pensioners' assets, reinstating traditional American property rights and making secured credit secure once more. It seemed to some an exercise in futility: The judge in the Coyotes case commented from the bench that the "poor pension manager from Indiana . . . was kind of like the gentlemen in Tiananmen Square when the tanks came rolling."

On Dec. 14, 2009, in the under-reported news story of the year, the Supreme Court granted the request of Indiana pensioners and took the case. The Court immediately ruled from the bench to strike down the decision of the Second Circuit Court of Appeals, eliminating it as a possible precedent in any future proceeding. Our retirees are still out the $6 million but enjoyed the small vindication of being awarded the court clerk's costs at Chrysler's expense.

The nation is not safe from crony capitalism. In the past year we've experienced the nationalization of the student loan industry and the passage of national health-care and financial-services regulation, each of which is rife with new opportunities for government favoritism and preferential handouts to favored corporations like Chrysler.

But thanks to a quiet correction by the Supreme Court—and a little Hoosier stubbornness—the rule of law has been re-established. The greatest benefits will accrue not to lenders and borrowers but to all those whose jobs are created because investors once again can trust that the money they've risked is safe from seizure by the state.

Mr. Daniels, a Republican, is the governor of Indiana.