The Chrysler effect : the impact of the Chrysler bailout on borrowing costs

Did the U.S. government's intervention in the Chrysler reorganization overturn bankruptcy law? Critics argue that the government-sponsored reorganization impermissibly elevated claims of the auto union over those of Chrysler's other creditors. If the critics are correct, businesses might suffer an increase in their cost of debt because creditors will perceive a new risk, that organized labor might leap-frog them in bankruptcy. This paper examines the financial market wherethis effect would be most detectible, the market for bonds of highly unionized companies. The authors find no evidence of a negative reaction to the Chrysler bailout by bondholders of unionized firms. They thus reject the notion that investors perceived a distortion of bankruptcy priorities. To the contrary, bondholders of unionized firms reacted positively to the Chrysler bailout. This evidence suggests that bondholders interpreted the Chrysler bailout as a signal that the government will stand behind unionized firms. The results are consistent with the notion that too-big-to-fail government policies generate moral hazard in the credit markets.