June 3 (Bloomberg) -- Bondholders have a new risk to contend with -- the Obama administration’s policy of “shared sacrifice.”

The government’s approach to the bankruptcies of General Motors Corp. and Chrysler LLC illustrates how this new, unstated policy works: Bondholders are told to give up legal rights, and cash, as part of a government-mandated tradeoff that favors a politically connected special-interest group.

The big threat is that this policy will extend to all bonds, including Treasury and municipal debt, not just corporate obligations.

That sounds alarmist, even extreme. After all, the government has gone to incredible lengths to assure U.S. creditors -- specifically, central banks that own trillions of dollars in Treasuries and other government-guaranteed debt -- they won’t have to bear any financial-crisis pain.

Yet with California in a budget crisis, worries over all kinds of supposedly safe debt abound. And Wall Street’s disenchantment runs so deep in the wake of GM and Chrysler that once-unthinkable scenarios are being discussed.

One example: a speech by well-known hedge-fund manager David Einhorn at last week’s Ira W. Sohn Investment Research Conference. While focusing much of his talk on ratings companies and a bet his firm has made against Moody’s Corp., Einhorn also attacked President Barack Obama’s policy toward bondholders and the danger it poses to creditors of all stripes.

The president, Einhorn said, had introduced a “quixotic idea” into credit markets: “that creditor recoveries in troubled situations can be determined by an arbitrary sense of shared sacrifice rather than legal agreements and long- established prior practice.”

Just How Far

Einhorn raised the question of just how far the administration would go in pursuing this new policy, especially if the interests of bondholders again came into conflict with politically favored groups.

“When teachers and firefighters are losing jobs and benefits, will municipal bondholders be asked to share in the collective sacrifice?” he asked. “Might the shared-sacrifice theory eventually extend into the U.S. Treasury market during a crisis?”

This chilling thought reflects a sentiment in credit markets that the rule of law is being eroded.

That theme was echoed at the Sohn conference by Paul Singer, head of Elliot Associates LP, one of the biggest and most successful hedge-fund managers.

Singer’s funds have used the courts to enforce their rights as creditors. He spoke of his concern the law will be circumvented.

Can’t Lose Capital

As Singer lamented, when that happens, capital tends to find a new home. That would be worrisome, given that the U.S. needs to raise trillions of dollars to fund all the Obama administration’s bailout and stimulus plans.

In the meantime, debt investors will have to consider new risk factors when weighing an investment. These include the size of a company’s workforce; the proportion that is unionized; whether or not the company, or a sizeable part of the unionized workforce, is in a political swing state; and whether it has operations in the home district or state of an important congressional committee chairman.

The GM case showed that these issues, not usually considerations for investors, can be just as important as a bond’s yield-to-maturity or covenants.

Union Fund Wins

In the run-up to GM’s Monday bankruptcy filing, bondholders were told they would do far worse in a government-organized and -financed restructuring than would a health-care trust fund for GM’s unionized retirees. That was the case even though bondholders were owed $27 billion versus $20 billion for the trust, and even though bondholders’ claims were legally equivalent to those of the trust.

True, the government sweetened the offer to bondholders at the last minute and agreed to put more taxpayer money into a new GM. Still, that deal wasn’t anywhere near as good as the upgraded offer given to the trust, which is represented by the United Auto Workers union.

The deal certainly didn’t represent, as Obama said during a Monday press conference, an “equitable outcome” for bondholders.

Bondholders were given a 10 percent stake in the new GM and warrants to purchase additional shares down the road. The employee trust fund, meanwhile, received a 17.5 percent equity stake, as well as $6.5 billion in new preferred stock. This preferred stock pays a 9 percent dividend. So the trust will receive $585 million each year, while bondholders stew.

No Fair Shake

Much of the ultimate recovery for bondholders and the trust depends on the value ascribed to GM’s new stock, years into the future. No matter how you cut it, though, bondholders don’t get a fair shake.

“The UAW gets a recovery of five times the bondholders’ under reasonably upbeat scenarios,” CreditSights Inc. analyst Glenn Reynolds wrote in a research note. “This is just the fact.”

So bondholders now know how the Obama administration’s “shared-sacrifice” policy will work out for them. After GM, they can’t say they weren’t warned.

(David Reilly is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: David Reilly at dreilly14@bloomberg.net

Last Updated: June 3, 2009 00:01 EDT