When the New York Times begins to raise the possibility of giving bondholders haircuts instead of making the taxpayer bear the entire cost of bailouts, we may think there is a change in public opinion, but will it change government policy? Well, Timid Tim is “in control”, so…
Hussman tells it like it is:
Understand that the money that the government is throwing around represents a transfer of wealth from an unwitting public to the bondholders of mismanaged financial corporations, even while foreclosures continue. Even if the Fed buys up the Treasuries being issued, and thereby “monetizes” the debt, that increase in government liabilities will mean a long-term erosion in the purchasing power of people on relatively fixed incomes.
How did the banks get so powerful?
As if he writes in response to the issue we and others have repeatedly raised, Tim Bond at FT answers why he thinks bank bond holders should NOT be forced to take a haircut. We don’t agree with his analysis, but if one does, then an argument can be made, like Tim’s, that the equity bear market is over, so read the entire thing…
The main objective of government assistance is to prevent a generalised bank run, thereby giving banks sufficient stability to earn their way through the bad debt cycle. This objective is achieved by maintaining confidence that banks can pay their debts.
Any action that hurts the interests of senior bank bond holders would be opposed to this objective. Senior bonds are a necessary source of funding for banks. Crucially, they supply longer term liquidity and thus play a valuable role in reducing the vulnerability of banks to the maturity mismatch between long term loans and short term funding, the Achilles heel that has recently caused the downfall of several institutions.
In most European jurisdictions, senior bank debt explicitly ranks pari passu with deposits. So any government action that might hurt senior bank debt holders would also hurt depositors, achieving the precise opposite to the presumed intention. In the US, although senior bank bonds rank below deposits, exactly the same arguments apply. Any default to senior note holders is tantamount to allowing the bank to fail, an eventuality that can have, as we saw in the case of Lehman and during the Great Depression, cataclysmic economic effects. As such, the risk that governments might opt for such a policy is virtually zero.
