With Chrysler now in bankruptcy, our attention will turn to whether Obama’s promise of a short and surgical bankruptcy, coupled with an alliance agreement with Fiat, will ultimately be realized. Steve Jakubowski has presented some interesting legal analysis of the Chrysler bankruptcy (see Assessing the Financial Carnage and Testing the Limits of 363 – ht CalculatedRisk).

Although Steve analyzes the bankruptcy from a legal perspective, there are some interesting strategic dilemmas that emerge. For example, Steve went through the legal filings to piece together Chrysler’s balance sheet and financial standing. He points out:

• The claims of the top 50 unsecured creditors total $730 million, with total trade at about $1.5 billion.
• The claims of the senior secured lenders total $6.9 billion.
• The USA is owed $4 billion, secured by a third priority lien.
• Cerberus and Damiler AG are owed $2 billion secured by a second priority lien.
• An additional approximately $8.5 billion is owed to the VEBA funds that were designed to cover the costs of unionized retiree health benefits.

This raises an interesting set of questions. For example, why would the secured lenders be willing to take $2 billion to settle their claims? After all, they are technically first in line (after the DIP financier). Moreover, they feel that the federal government tried to cram down a Fiat deal in which unsecured creditors have been unduly favored over secured creditors. They argue that in liquidation they might be better off trying to recoup their money. Assuming Chrysler’s assets still have some value (which the truck, minivan, and Jeep lines probably do), they might be right. So to a certain extent I cannot blame them for not backing down.

By contrast, Chrysler’s representatives maintain that the secured creditors are likely to recover very little in the event of liquidation. As Steve points out:

In the end, however, the matter will be determined by the opinion testimony elicited from the parties’ opposing experts (with Houlihan Lokey’s Eric Siegert representing the dissenting lenders and Capstone Advisory Group’s Robert Manzo, who prepared this 166 page first day affidavit / expert report, representing Chrysler).  Notably, Manzo concludes in his affidavit (pp. 26-27) that:

Based on the Liquidation Analysis, the First Lien holders are expected to recover between 9% and 38% of their claims, on a net present value basis, [which] translates into a range of between $654 million and $2.6 billion.  It is my professional opinion that given the market developments subsequent to this analysis, coupled with the limited success of other OEM effort to move individual car lines, the First Lien holders would likely recover at the low end of this range as part of any liquidation of the Company. The U.S. Treasury is only expected to recover between 3% and 6% of its claims.

Since Chrysler obviously favors the Fiat deal, it is not a surprise that they “believe” that the first lien holders are making a mistake. I am not so sure I agree with that position, as again, I think there might be a bit more value in Chrysler’s products and brands.

Another interesting point that comes out of Steve’s analysis is that the US government is third in line, after the bank lenders and Cerberus/Daimler. Therefore, in liquidation, it is unclear that the taxpayer would receive much in return. But that begs the question, is it better to get nothing in return for a $4 Billion loan, or lend invest an additional $6 Billion to support a Fiat deal (putting the taxpayer $10 Billion in the hole) with the prospect of still getting nothing in return? And under the Fiat scenario, the federal government’s claim would only be in equity, meaning that in the event of future bankruptcy, the taxpayer will be among the first to get wiped out. So again, it’s unclear to me that the Fiat deal is in the best interests of the taxpayer.

Now I am not a legal expert, but Steve makes some interesting points with respect to the role of the judge in cases such as these. He writes:

In concluding that the debtor…should be sold outside of the context of a reorganization plan, he [the judge] asks:

• Is there evidence of a need for speed?
• What is the business justification?
• Is the case sufficiently mature to assure due process?
• Is the proposed APA sufficiently straightforward to facilitate competitive bids or is the purchaser the only potential interested party?
• Have the assets been aggressively marketed in an active market?
• Are the fiduciaries that control the debtor truly disinterested?
• Does the proposed sale include all of a debtor’s assets and does it include the “crown jewel” (noting that “the likelihood of approval of the § 363 sale is inversely proportional to the percentage of the value of the debtor’s assets that are to be sold”)?
• What extraordinary protections does the purchaser want?
• How burdensome would it be to propose the sale as part of confirmation of a chapter 11 plan?
• Who will benefit from the sale?
• Are special adequate protection measures necessary and possible?
• Was the hearing a true adversary presentation?  Is the integrity of the bankruptcy process protected?
• What other factors apply to the case at hand that tip the balance or that overweigh the evaluative factors set forth above?

The most interesting question to me is the one about “Are the fiduciaries that control the debtor truly disinterested?” In this case the fiduciary that controls the debtor is the federal government since it is my understanding that it will act as a the trustee. On that basis, since the government is both creditor and trustee, how can it be disinterested??

Also, another interesting consideration is whether the Fiat deal unduly favors the auto union, and Chrysler’s retirees, vis-a-vis secured creditors. Again, I am not a legal expert, so it is not entirely crystal clear to me which claims comes first in bankruptcy (secured creditor claims or VEBA claims), although if I am not mistaken, the claims of the auto union should be unsecured claims and therefore junior to secured creditors. Either way, a 55% ownership stake in Chrysler for the union seemed a bit rich to me.

Steve concludes by reminding readers:

never forget that in litigation, nothing is guaranteed.  Indeed, much depends on the judge drawn.  The judge overseeing this case is Judge Arthur Gonzalez, who proved…that he will adhere to what he believes the law requires, even if the financial markets turn upside down because of it.

So, who will win?  Really, only the true speculator and/or holder of Chrysler credit default swaps will (and perhaps Fiat if they–unlike their predecessors–can make it work), as my first post on the financial carnage at Chrysler demonstrates.  My guess is that after much briefing, discovery, and expedited litigation over the next 60 days, Judge Gonzalez will show enough angst to worry both sides that they stand to lose, thus resulting in a compromise that settles the matter and allows the transaction to go forward.  But with all Chrysler plants and operations now idled pending a final sale, the pressure to get the deal consummated and return people to work will be so overwhelming that it’s hard to imagine Judge Gonzalez not approving the transaction in some form that’s acceptable to everyone (except perhaps the dissenting lenders).

Steve claims that there is chance that Fiat might be a winner if they can make this deal work. As I’ve written before, I view Fiat’s chances of success as a low probability event (see Fiasco for Fiat or Now Introducing Fiat/Chrysler).

Irrespective of the outcome, one thing is certain: This is going to be a fascinating showdown – one that is extremely complex from both a legal and strategic perspective.

UPDATE: It looks like the deal is off (for now at least). Even the article to which I linked below has been pulled in favor of another. The latest is that Chrysler’s creditors rejected the government’s offer (see Chrysler Talks Seen on the Rocks). The question now becomes: Is this truly a temporary bankruptcy in which the deal with Fiat is done but minor structural details need to be ironed out; or, will everyone (Fiat, Chrysler creditors, the federal government, and the UAW) come to their senses and realize that this is a lost cause and that Chrysler should be liquidated?

I leave the original post, as it expresses many of my concerns regarding a Fiat/Chrysler alliance.

——————————————————-

And there you have it.

According to the Associated Press, Fiat will sign a pact with Chrysler to officially extend its existence as a going concern (see Fiat to Sign Partnership Deal).

Italian automaker Fiat Group SpA will sign paperwork to become a partner with Chrysler LLC by Thursday, according to three people briefed on the deal…

“It’ll be signed by tomorrow, I know that,” one of the people [familiar with the deal] told The Associated Press.

As I’ve mentioned before, I am not convinced that this alliance is the best outcome for Chrysler, Fiat, the auto industry, or the U.S. taxpayer (see Fiasco for Fiat? or Chrysler Miracle for background). The following issues concern me:

1. Are the auto union concessions enough to make Chrysler viable for the long run, …especially since the various agreements with the auto union did not involve wage cuts that would make Chrysler more competitive on an operating basis moving forward.
2. Is the taxpayer getting a fair shake in exchanging $10 Billion ($4 Billion in outstanding loans plus an additional $6 Billion cash) for a 10% stake in Chrysler? I am assuming that the additional $6 Billion that the federal government intends to pump into Chrysler has already been factored into its 10% stake in Chrysler. If so, by that calculus, Chrysler would be worth an imputed $100 Billion (if not, at the very least they are valuing Chrysler at $40 Billion). That’s more-or-less the current valuation of GM. Is Chrysler really worth that much?? Under such generous exchange terms, it is possible that the taxpayer would have been better off calling the preexisting loans and simply liquidating Chrysler.
3. Is Fiat up to the task? It has entered and exited the U.S. market once already. Are we looking at a possible repeat performance? Let’s not forget that Fiat is a firm that, as little as two years ago, was on the verge of bankruptcy itself.
4. Fiat is not prepared for what it is about to get into by acquiring a stake in Chrysler. Global expansion and integration is difficult enough in the best of circumstances, but Fiat is now acquiring a feeble company with little in the way of design and product capabilities. It is not clear that Fiat will be able to manage the cross-cultural complexities associated with this deal. Moreover, it is possible that Chrysler’s products (even with technology infusions from Fiat) will not improve quickly enough for it to become a profitable enterprise.
5. The global auto industry continues to be plagued by massive overcapacity. Keeping a weak competitor like Chrysler around will certainly not resolve systemic overcapacity in any meaningful way.

So while it looks like there is currently a future for Chrysler, it might prove to be a temporary future. It is entirely possible that despite the effort, Chrysler might end up right back in the same place in a few short years – on the verge of bankruptcy.

In previous posts (see Chrysler Still Needs a Miracle or Chrysler/Fiat Update) I suggested that the Fiat/Chrysler deal looked increasingly like a longshot. Fiat was asking for deep concessions from both the auto union and Chrysler’s creditors, and it seemed unlikely that Fiat was going to receive those concessions.

But over the past few days, the Obama Administration, the auto union, and Chrysler’s creditors seemed to have come to some sort of understanding (see Treasury Close to Deal with Chrysler Creditors, Chrysler Reaches Agreement with UAW, and UAW Gets 55%).

Hallelujah??

Maybe, but not so fast. Several issues remain:

1. Creditors must agree to the debt cancellation.

According to the NY Times:

Chrysler has about $6.9 billion in secured debt owned by big banks like Citigroup and JPMorgan Chase and a group of hedge funds. Under the proposal, all of the debt would be canceled in exchange for $2 billion in cash…

The Treasury drew up the latest proposal in consultation with Chrysler’s biggest secured creditors, which hold about 70 percent of the company’s secured debt. It requires approval by almost all of the secured lenders. That could be difficult as some lenders, including several hedge funds, may hold their ground and reject it.

2. The issue of pay for union workers must still be resolved. Although Chrysler, the federal government, and the union have come to terms with respect to pension and benefits, my understanding is that they have not yet reached a meaningful agreement to reduce wages. Just how important are wage reductions to Fiat? That remains to be seen. According to the Michigan Messenger:

The new agreement does not cut wages, but it does apparently reduce Chrysler’s commitment to pay into the UAW-run retiree health care fund.

3. According to the latest accord, the auto union will get a 55% equity share in Chrysler. The US government will get a 10% share. Fiat would get a 20% share. Where does the other 15% go? Is this 15% set aside for Fiat depending upon whether it meets performance goals? Will this 15%, or a portion of it, get doled out to Chrysler’s creditors? This was not entirely clear to me.

4. Ultimately, Fiat needs to agree to be party to the alliance. Until that happens, there is no deal. Time will tell if these concessions are enough to convince Fiat that the deal is worthwhile.

Nevertheless, given the concessions that all parties have made to help Chrysler avert bankruptcy, a Fiat alliance seems far more likely today than it did as little as one week ago. Chrysler is no longer looking for a miracle. Perhaps now just a random act of kindness.

But assuming a Fiat/Chrysler deal goes through, the question then becomes: Is this the best outcome for Fiat, Chrysler, and the auto industry? It is not entirely clear. The global auto industry continues to be plagued by massive overcapacity. Keeping a weak competitor around will certainly not resolve systemic overcapacity.

For Fiat, it might be a bit premature to re-enter the U.S. market (the most competitive auto market in the world) and sign on for a complicated global expansion/integration (see Fiasco for Fiat?). Let’s also not forget that Fiat is a firm that, as little as two years ago, was on the verge of bankruptcy itself.

Finally, for Chrysler, it is not clear that its products (even with technology infusions from Fiat) can improve quickly enough for it to once again become a profitable enterprise. For this reason, and as I’ve mentioned before, Chrysler likely needs more than Fiat and an additional $6 Billion infusion from the federal government to survive.

So even if the deal goes through this week, it is entirely possible that Chrysler might end up right back in the same place – on the verge of bankruptcy.

And we wait…

Last week, in the post Chrysler/Fiat Update, I suggested that Chrylser’s debtholders would likely be better off with Chrysler in bankruptcy. I wrote:

Some creditors (e.g., secured bondholders debtholders) would likely be better off with Chrysler in bankruptcy than make the kinds of concessions that would allow the Fiat deal to go through.

For this reason, among a host of others, I concluded:

Chrysler now needs a miracle to survive.

Sure enough, as reported yesterday in the Wall Street Journal (see Banks Reject U.S. Terms for Cutting Chrysler Debt), Chrysler’s debtholders seem unwilling to make the necessary concessions.

A group of big banks and other lenders rebuffed a Treasury Department request that they slash 85% of Chrysler LLC’s secured debt, proposing instead to eliminate about 35% in exchange for a minority stake in the restructured car maker and a seat on its board.

The lenders’ counteroffer marks a significant act of brinksmanship as the banks and the Obama administration’s auto task force duel over concessions to avoid liquidating the country’s third-largest car company.

In their five-page counteroffer, which was sent to the Treasury late Monday, the lenders said they are prepared to cut Chrysler’s first-lien debt by $2.4 billion, or down to about $4.5 billion, in exchange for a 40% equity stake and a Chrysler board seat, according to a copy of the proposal provided by individuals outside the lenders’ group.

In making their case for a significantly smaller sacrifice than what the government wants, the lenders have argued that their fiduciary duty to their own shareholders and investors requires them to recoup as much as possible from the car maker. The lenders have told Treasury officials they believe they could recover at least 65% of their loans if Chrysler is liquidated in bankruptcy.

Tick, tick, tick. We are now one week from the government imposed deadline. And we aren’t any closer to a deal. Fiat wants the auto union and Chrylser’s creditors to grant more concessions. Chrylser’s creditors and the auto union do not seem particularly motivated to make such concessions. What’s more, they both want Fiat to put more skin in the game.

Looks like time for that miracle is running out fast. Now let’s see if the Obama administration has the fortitude to make good on its bankruptcy threat…

From the vault of “Oh Gee, What a Shock” comes the latest pronouncement from Fiat: Concessions or No Chrysler Deal. According to the Associated Press:

Automaker Fiat Group SpA will walk away from a deal to take a 20-percent stake in Chrysler LLC if the U.S. automaker’s unions don’t agree to major cost cuts, Fiat CEO Sergio Marchionne said in an interview published Wednesday.

…Chrysler…needs concessions from creditors and unions to ink the Fiat deal.

My comment: As I suggested in a prior post (see Finally a Sensible Approach), Chrysler needs much more to survive than Fiat and the $6 Billion that the US Government has promised. Moreover, since Chrysler has no other options and the federal government has given Chrysler an ultimatum with respect to the Fiat deal, Fiat can play a very strong hand in any negotiation. And they will.

“Absolutely we are prepared to walk. There is no doubt in my mind,” Marchionne told the Toronto Globe and Mail. “We cannot commit to this organization unless we see light at the end of the tunnel.”

Marchionne said there is a 50 percent chance the deal will fail because of lack of progress in labor negotiations in both the United States and Canada.

“The dialogue is out of sync,” Marchionne said. “I think they need to see what state the industry is in. Canada and the U.S. are coming in as the lender of last resort. … No one else would put a dollar in. This is the worst condemnation of the viability of this business.”

My comment: I think Marchionne’s estimate, that there is 50% chance that the deal goes through, is wildly optimistic. As with GM, it will be very difficult for Fiat/Chrysler to extract meaningful concessions from the auto unions and Chrysler’s various creditors. Some creditors (e.g., secured bondholders debtholders) would likely be better off with Chrysler in bankruptcy than make the kinds of concessions that would allow the Fiat deal to go through. Therefore, and as I alluded to in my previous post, Chrysler now needs a miracle to survive.

And we wait…

Advertising Age recently asked me to write a short Op-Ed summarizing my reaction to the Obama administration’s stance toward GM and Chrysler. You can find the full piece on the Advertising Age website, or by clicking on the accompanying link (The Obama Administration Got it Right).

For those of you who have followed this blog, my opinion should not come as a surprise. I have expressed sentiment consistent with the Auto Task Force’s decision for the last half-year or more (see GM and Chrysler: Finally a Sensible Approach, Pre-Packaged Bankruptcy, Preventing Moral Hazard, and Aid for Chrysler? Just say No! for background).

Given that the decisions made by the Obama administration were largely consistent what I had been advocating, I am sanguine.

In January I predicted (see Notable Bankruptcies of 2008) that “major” bankruptcies in 2009 would challenge the 383 mark set in 2001 (the high-water mark after the dotcom bubble). I even suggested that it was possible that we could exceed 400 “major” bankruptcies in 2009.

According to Bankruptcydata.com, there have been 90 “major” filings thus far in 2009. Assuming that bankruptcies are equally distributed throughout the year, this puts us on pace for 360 bankruptcies. I fully expect the filing pace to quicken as the year goes on, and as the economy continues to deteriorate.

Below you can find an updated list of what I see as the “noteworthy” bankruptcies of 2009, as reported by Bankrupctydata.com (please note that this is not an exhaustive list):

• Bearingpoint, Inc. (Consulting)
• BI-LO, LLC (Supermarkets)
• Charter Communications, Inc. (Telecom)
• Chemtura Corporation (Chemicals)
• Fleetwood Enterprises, Inc. (Recreational Vehicles)
• Fortunoff Holdings, LLC (Retail)
• Goody’s LLC (Retail)
• Herbst Gaming, Inc. (Gambling)
• Idearc (Publishing)
• Journal Register Companies (Newspapers)
• Lyondell Chemical Company (Chemicals)
• Magna Entertainment (Gambling)
• Masonite Corporation (Real Estate Manufacturing)
• Midway Games, Inc. (Entertainment Software)
• Monaco Coach Corporation (Recreational Vehicles)
• Nortel Networks, Inc. (Telecom)
• Pacific Energy (Oil & Gas)
• Philadelphia Newspapers, LLC (Newspapers)
• Ritz Camera Centers, Inc. (Retail)
• Shane Company (Jewelry)
• Silicon Graphics, Inc. (IT/Computing)
• Silver State Bancorp (Banking)
• Smurfit-Stone Container Corporation (Paper Manufacturing)
• Spectrum Brands (Consumer Products)
• Star Tribune Companies (Newspapers)
• Sun-Times Media Group, Inc. (Newspapers)
• Tarragon Corporation (Real Estate)
• Trump Entertainment (Gambling)
• WL Homes, LLC (Real Estate)
• Young Broadcasting, Inc. (Television)

In addition to “major” bankruptcies (e.g., those firms with assets greater than $50M) tracked by Bankruptcydata, the U.S. government tracks all bankruptcy filings by type (e.g., Chapter 7, Chapter 11, Chapter 13). You can find detailed bankruptcy statistics at the U.S. Courts website. Business bankruptcies for 2008 came in at 43,546, slightly shy of my 45,000 prediction; however, that still represents a 54% increase over 2007, and the greatest number of business bankruptcies since 1997.

The chart above presents annual (calendar year) business bankruptcy filings from 1990-2008 (click on the picture for a larger image). Interestingly, the number of filings had been trending steadily downward from 1990 through 2006. In 2007 the numbers started to reverse course. I expect that trend to continue in 2009, with total business bankruptcies reaching 55,000.

The big story today is the Obama administration’s decisions regarding GM and Chrysler aid (see US Lays Down Terms for Bailout). I won’t spend time re-hashing the specifics; instead, I will provide commentary on the plan as it has been advanced, assuming you already know the specifics.

Overall, I think this plan represents a sensible approach. It recognizes that there is substantial heterogeneity across GM and Chrysler. Their importance to the broader economy differs. GM is obviously the more systemically important firm of the two. Moreover, the two are not on equal footing with respect to future prospects. GM’s product portfolio moving forward is far superior. For these reasons, I have been an advocate of treating GM and Chrysler differently (see Pre-Packaged Bankruptcy, Preventing Moral Hazard, and Aid for Chrysler? Just say No! for details).

Kudos to the auto task force for recognizing this and responding accordingly. As a result, the Obama administration has committed to seeing GM through this crisis. Chrysler, by contrast, is on its own.

The Obama administration will provide additional aid for GM, and has committed to an out-of-court restructuring, provided GM receives substantial concessions from its creditors and its union. In the absence of a meaningful agreement with the UAW and bondholders, at the very least, the US government has pre-committed to act as GM’s DIP financier in bankruptcy, and guarantee its existence through the restructuring process (see Could GM Survive Bankruptcy?). The threat of bankruptcy for GM (hopefully a credible one) should be enough to elicit cooperation from the bondholders and the UAW.

With respect to Chrysler, this is the beginning of the end. The administration has told Chrysler that it has 30 days to strike a deal with Fiat or else it will not receive any additional public funds. This creates a dilemma for Chrysler. It needs Fiat to survive, but Fiat needs the US government to commit a significant amount of capital before it agrees to any deal. After all, Fiat does not intend to inject capital into Chrysler (see Fiasco for Fiat and Chrysler and Fiat Revisited). What is clear is that Chrysler would require significantly more to survive than the $6 Billion that the government has promised in the event that they strike a deal with Fiat (see GM, Chrysler Need More Aid than Requested). Fiat knows that. Moreover, the likelihood that the US government will continue to throw money at Chrysler (in excess of the $6 Billion promised), even if they strike a deal with Fiat, is remote. Fiat knows that too.

So the writing is on the wall. Chrysler is likely finished.

What is unclear to me from the plan as it has thus far been outlined, is whether the US government acts as the DIP financier when Chrysler goes bankrupt, or whether it allows Chrysler to be liquidated. Obama seems to be hinting (as I listen in real time) that the government will act as DIP financier to Chrysler, …but I am skeptical.

Irrespective of whether the US government acts as Chrysler’s DIP financier, Chrysler will serve as a lesson to GM, its creditors, and its bondholders union. Allowing Chrysler to go bankrupt should be enough to wake up GM’s creditors and bondholders union to the reality that US taxpayers will not support them indefinitely.

As a first shot over the bow, the Obama administration began by ousting Rick Wagoner.

UPDATE @ 11:30am

One last point, some have been asking why not just impose bankruptcy now (at the very least for Chrysler) if that will be the endgame anyway. I think the answer to this question lies in the shock that would have reverberated throughout the market. A sudden bankruptcy would have caused panic among stakeholders of all sorts. At this point, bankruptcy for Chrysler is all but assured. Bankruptcy for GM is a real possibility (perhaps 50/50). So the point of today’s action (stopping just short of imposing bankruptcy) is to forewarn market participants. Given this information, it would be prudent for those who have a stake in this outcome to get their affairs in order.

Several months ago, Fiat announced an alliance with Chrysler in which it would take a 35% ownership stake in Chrysler. In a post entitled Fiasco for Fiat, I discussed the alliance’s prospects for success, and what the deal meant for Chrysler and its creditors. With respect to Chrysler’s outstanding debt, I wrote:

As a Chrysler creditor (a U.S. taxpayer), anything that increases the likelihood, even infinitesimally, of receiving a return on my investment makes me happy. The U.S. taxpayer (and by corollary, the U.S. government) should therefore be positively predisposed toward this deal, taking comfort in the fact that, at the very least, in exchange for a 35% ownership stake in Chrysler, Fiat should be commensurately responsible for 35% of the liabilities. This should come as welcome news, assuming Fiat can keep Chrysler viable long enough to repay the U.S. government.

I then expressed incredulity at Fiat’s willingness to sign itself up for 35% of Chrysler’s liabilities:

Personally, I can’t believe that signing up for 35% of the liabilities of Chrysler would not be enough to scare off Fiat, …or any other potential investor for that matter.

But who am I to object. Caveat Emptor.

Well guess what?? Surprise, surprise. Fiat is not willing to assume 35% of the liabilities. According to recent reports (see Fiat Not to Take Debt), Fiat, while interested in owning 35% of Chrysler’s upside, is not interested in inheriting 35% of Chrysler’s problems. It’s like Geithner’s Public Private Investment Partnership – Fiat wants to be able to benefit from the upside while Chrysler’s current shareholders/creditors bear the downside risk (heads I win, tails you lose). According to the AP article:

A public tiff between Italian automaker Fiat SpA and Chrysler LLC apparently ended Friday when Chrysler rescinded a statement on its Web site that Fiat would be responsible for part of Chrysler’s debt if the two companies join forces.

Chrysler, in a Web video on Thursday explaining why an alliance for the two companies would be good for Chrysler and the country, said Fiat would be responsible for 35 percent of what Chrysler owed to the U.S. government.

But Fiat on Friday denied that it would be responsible for any of Chrysler’s debt.

…Chrysler, in a statement issued Friday, reversed the claim it made on the Web and said Fiat would become an equity holder.

“To clarify, this does not mean Fiat would assume responsibility for any of Chrysler LLC’s debt,” the statement said.

Fiat Group said in a statement Friday said it “intends to make absolutely clear that the proposed alliance will not entail the assumption of any current or future indebtedness to Chrysler.”

I have to admit, from a transactional perspective, I am not sure exactly how such an arrangement could be structured – i.e., how a firm can acquire 35% of the residual claims to a firm but not also be liable for 35% of the outstanding claims on the firm. Call me crazy, but that’s what I thought “ownership” meant. But that’s something for the lawyers to figure out.

What most interests me is what Fiat’s lack of commitment to Chrysler might mean for Chrysler’s prospects of receiving additional government aid. Answer: It cannot bode well for Chrysler.

Personally, I do not believe Chrysler deserves additional government loans with or without Fiat (see The GM and Chrysler Plans, Aid for Chrysler? Just say No! and Is the End Nigh for Chrysler? for details). That notwithstanding, the latest Fiat developments cannot help.

There hasn’t been much inspiring me to write these days. The news across the board has been pretty much the same – the economy stinks, joblessness is increasing, housing continues its downward spiral, consumption is nowhere near recovery, bankruptcies are on the rise, banks are under stress, corporations are struggling, and Jon Stewart continues his hysterical rant at the folly that is CNBC. Did I miss anything??

Seems like these days we’re in a holding pattern waiting for the results of the bank stress tests and a decision on the GM/Chrysler aid.

So while we’re all waiting, I came across an interesting issue in the debate about the merits of various approaches to the banking crisis (e.g., nationalization versus ringfencing troubled assets versus good bank/bad bank).  Paul Krugman and Simon Johnson (and the rest of the folks at The Baseline Scenario) have recently talked about what to do about bank liabilities; specifically, debt (not liabilities to depositors).

As Krugman points out (see Anti-nationalization Arguments):

some decision must be reached on bank liabilities. Sweden guaranteed all of them. If forced to say, I would go the Swedish route; but of course we can’t do that unless we’re prepared to put all troubled banks in receivership. And I’m ready to be persuaded that some debts should not be honored — this is a deeply technical question.

What’s clear, however, is that the current system, of implicit maybe-kinda guarantees on bank liabilities — call it wink-wink-nudge-nudge-say-no-more banking policy — is failing badly.

From The Baseline Scenario (see Quick Note on Liabilities):

…the government has been doing everything it can to imply that bank creditors (at least for “systemically important” banks) will be protected, without saying so explicitly, because that would suddenly increase the potential liabilities of the government by trillions of dollars.

What’s clear is that several of the largest US banks (those subject to the stress test) are insolvent – their liabilities exceed the value of their assets. For those banks that are insolvent, shareholders will get wiped out, probably through nationalization, however administered. After shareholders get wiped out, the fact remains that the value of the remaining assets (after depositors are made whole) will not make existing creditors whole.

So the question remains, should the US government (taxpayers) guarantee the liabilities?

One of the issues, as I see it, depends upon the identity of those creditors. And this is where it gets complicated. Maybe this is what Krugman means by “deeply technical” (although perhaps he had something else in mind).

To the extent that US bank creditors include large sovereign wealth funds and central banks, forcing bondholders to take a haircut may come with political consequences. In contrast to small, private creditors, sovereigns have political and economic recourse. And, after all, we will probably need to rely on some of these same actors to fund our current deficit.

For this reason, I am inclined to believe that we will be forced to guarantee the liabilities of banks we nationalize, a la Sweden.

And we wait.