Auto Bailout June 4, 2009, 10:28PM EST

Indiana Teachers and Cops vs. Chrysler

Indiana pension funds now pin hopes on the Supreme Court hearing their bid to block Chrysler's sale to Fiat

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As gas prices hovered around $4 a gallon and American automakers watched their pickup-truck and sport-utility sales plummet last summer, investment managers for some 100,000 Indiana teachers, police officers, and other civil servants poured millions of pension dollars into what the funds considered a safe investment: secured debt in Chrysler. Now, as the company speeds toward an exit from bankruptcy court, they are crying foul.

On Friday, the Second U.S. Circuit Court of Appeals agreed to block the Chrysler sale to Fiat, but only until 4 p.m. EDT on June 8—essentially giving the pension funds the weekend to try to get the U.S. Supreme Court to hear their arguments. It is not clear the high court will agree to consider the case. The Indiana State Teachers Retirement Fund, the Indiana State Police Pension Trust, and the Indiana Major Moves Construction Fund argue that the federal government's intervention in the bankruptcy is unconstitutional, since the proposed plan will pay back unsecured lenders before those that were secured. The unsecured creditors and the United Auto Workers contend the sale is fair and is supported by a majority of Chrysler's creditors.

Should the Indiana pension funds have foreseen the risks ahead? With their Chrysler investment, those public employees became unlikely associates of the hedge fund managers and other bankers whom President Obama blasted on national television in late April as "a small group of speculators" trying to block the government's attempts to revive Chrysler. They arrived in that position last July when the funds paid 43¢ on the dollar, or about $17 million, for approximately $42 million worth of Chrysler's almost $7 billion in secured debt.

Pension funds moved into riskier plays

In branching out beyond blue chip stocks and ultra-safe bonds, the funds weren't alone. Facing shortfalls because of market setbacks, public-employee pension funds have increasingly looked toward riskier investments, including hedge funds. But by the time the Indiana funds invested in Chrysler, predictions about the future viability of the auto industry were becoming dire. Just a month prior to the purchase, in June 2008, Standard & Poor's (which, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP)) placed the corporate credit ratings of Chrysler, Ford Motor (F), and GM on "CreditWatch with negative implications." High gas prices, combined with a growing demand for smaller vehicles, prompted concerns about how rapidly the Big Three were burning through their remaining cash reserves.

"Even though the debt was secured, it was clear the auto industry was very, very troubled at this time," says Shelly Lombard, a credit analyst and portfolio manager of high-yield and distressed corporate securities at Gimme Credit. "If it wasn't, it wouldn't have been offered at such a steep discount." In this recession, Lombard says, even secured bank debt is not a guarantee. The market's low price could have been due to a lack of buyers or because the debt was impaired. She compares the deal to buying a house at a bargain price: "Either there's a divorce and the people just want to get out of there, or the foundation is cracked. In an industry in such turmoil, due diligence becomes even more critical."