Let me start by saying that I approve of Obama’s decision to force the hands of GM bond holders. They have been refusing to settle with GM, hoping that the government will back down and pay them off at a higher value. If GM goes bankrupt, they get nothing.

History:  they don’t want to settle because of the precedent set with Pimco and GMAC. 

When Bill Gross snaps his fingers, the Fed jumps. He’s the head of Pimco, the world’s largest and most influential bond investment house. Gross made money betting that the government would come in and rescue GMAC. When other bond holders were willing to swap debt for equity at 60 cents on the dollar, which allowed GMAC to become a bank and qualify for TARP money, Pimco pulled out. Pimco’s holdings rose as much as 83 percent, to 80.5 cents on the dollar. The other bond holders were quite righteously pissed.

Gross also made money betting that Fannie and Freddie would get bailed out. He basically went on CNBC and threatened the government:

On Sept. 7, three days after Gross’s CNBC appearance, the government placed Fannie and Freddie under conservatorship. That move trashed Fannie and Freddie’s common and preferred equity but provided a huge boost to their bonds – and to Pimco. The Total Return fund jumped 1.3%, or $1.7 billion.

Well, money managers often make statements that would help their investments. But a number of critics contend that Gross was giving the government an ultimatum. "He convinced the Treasury to keep his bonds from going to zero, or else he would stop lending money to distressed companies that were important to the economy," Cohan says. The U.S. government will need to raise lots of capital to fuel efforts to end the recession. That will mean issuing lots of bonds. Since Pimco is one of the few buyers capable of absorbing such vast amounts, Washington "can’t afford to let him walk away," says Cohan. "The government should recognize that just as some institutions are too big to fail, Pimco is too big to talk its book," says Rosner. He thinks that the government should have clipped bondholders as well as shareholders when it took over Fannie and Freddie.

Gross resigned from the GM bondholder negotiating committee in January, after Pimco reneged on their agreement to join the GMAC debt swap. GM bondholers are now saying that they want the government to secure the securities that bondholders get in the debt swap.

It’s notable that Alan Greenspan went to work as a consultant for Pimco after he left the Fed. Pimco recently said that the government needed to double its balance sheet in order to replace the amount of wealth destroyed in global financial crisis. Tell it to the Chinese, who are "worried" that in doing so, the US will drive down the value of its Treasury notes.

GM’s bonds tumbled this morning, and their credit default swaps were up. But there’s a giant game of chicken going on now between the government and bondholders, who are betting that the fallout of a bankruptcy would be worse for the government than paying them off.

It’s great to see the administration getting tough with auto industry, forcing Rick Waggonner from GM’s helm and demanding that they break their contracts with bond holders. We can only hope that this new forcefulness will manifest itself when dealing with the "too big to fail banks" now taking enormous risks with taxpayer money because there is no downside.

Good to know that we are evidently no longer hung up on being "a nation of laws" (Larry Summers) who can’t run a business from Washington DC.