The United States as Banana Republic

With GM deal almost in the bag, the Obama administration flushed what was left of the capitalistic system down the toilet, all to curry favor his favored constituents - the UAW. In the last proposal in a drastic re-definition of the rules of normal bankruptcy proceedings the bondholders will a receive a pittance, 10% of the company while the UAW will receive $10 Billion in cash and 39% of the company. I guess this is a bargain since the union at Chrysler may receive 55% of the company. Being a "secured creditor" now has little distinction since long established rules of law and of contract can be changed at a moments notice, just like they are in Hugo Chavez's Venezuela. No wonder Hugo is applauding Obama's socialist tendencies.

Of course these bondholders are in actually our pension and 401K funds, already bruised and battered by the economic collapse. The UAW, the number one prime reason that GM, Chrysler and Ford are facing liquidation (see earlier posts) will be rewarded with significant stakes in the company which will lessen the chances the company will indeed fix itself up. Instead they will suckle the teat of government.

Going forward what fool would lend money to company where the government can, at a whim the change the rules of the contract and leave you holding nothing but empty promises. Apparently, a lot of rules are on the chopping block nowadays. Instead of investing its much safer to just buy bold bars and hide them in the basement. Unfortunately, this is not likely to stimulate any economic activity.

In a capitalistic system the key ingredient to prosperity is confidence. In an environment where there is no confidence there is no investment and business activity languishes. In 1937 Franklin Roosevelt found out the hard way after repeated attacks on business had made many businessmen fearful that their assets would be confiscated or taxed into oblivion. In one of the darker moments Franklin asked to Eleanor why businessmen were not investing and growing the economy out of the depression. Eleanor's response: "Because they fear you".

Our first Treasury Secretary Alexander Hamilton fought for the rules of contract to be enforced, the rules of law to be followed, for securities to be freely transferrable and the government to act in a fiscally responsible manner. These were hard fought battles, but they resulted in the country that became and economic superpower.

Today, Obama may think that by helping his union supporters and ripping up the underpinning of our financial system he is doing the "right thing". Overturning long established principles for political purposes is something more likely to happen in a banana republic or a third world dictatorship. Once the trust and confidence of the business community is gone, they will not be easy to recreate. Foreign lenders like the Chinese understand that they too may be on the receiving end of this arbitrary behavior and are determined not to fall victim to it. Domestic lenders, which are needed to invest in GM and Chrysler if they are to get off the government life support will be fearful to invest since they see the current set of bondholders being screwed to help the union.

Instead it appears that faith in bonds and contracts will soon be as valuable as our faith in government - as valuable as a stack of Polish War Bonds.