Chrysler Bankruptcy Will Reopen the Pandora's Box of Counterparty Risk

Confirming earlier reports, Chrysler filed for bankruptcy Thursday afternoon, and formed an alliance with Fiat. Under the new partnership, Chrysler hopes to emerge from bankruptcy "in as little as 60 days," says The AP, which further reports: "The government, which has already poured $4 billion in loans into Chrysler, would provide up to $8 billion more to carry the company through bankruptcy, said senior administration officials speaking on condition of anonymity."

Chrysler's bondholders will now take their case to a bankruptcy court, drawing the ire of President Obama: “I don’t stand with those who held out when everyone else is making sacrifices,” he said today.

Earlier: Chrysler appears headed for a bankruptcy filing after talks with its creditors broke down. If Chrysler’s creditors refused to take about 30 cents on the dollar for their approximately $6.9 billion of debt, what are the odds GM bondholders will take 10 cents on the roughly $27 billion of GM debt they hold, as has been proposed? (GM bondholders have presented a counter offer featuring a debt for equity swap, The WSJ reports.)

And if the Obama administration’s hard line with the automakers' creditors fails, is there any hope for a change in the current policy of paying bank debt holders 100 cents on the dollar?

In the accompanying video, the implications of this latest twist in the Chrysler saga are discussed. “It feels like the bondholders are willing to take their chances in bankruptcy court,” Harrison says. “If that is the precedent that’s set, we enter into the realm of counterparty risk.”

Noting there are upwards of $400 trillion of derivatives contracts in the system, the issue of counterparty risk could rear its ugly head again, Harrison says. “We can only hope we’ve learned from past mistakes [with AIG] in how we deal with these institutions.”