The Great Bondholder Bailout Won't Even Save The Economy


One of the biggest outrages of the past 18 months has been the government’s decision–Bush AND Obama–to completely protect those who lent money to AIG, Citigroup, Bear Stearns, and other financial institutions (a.k.a., bondholders). 

Financial shareholders have gotten killed and taxpayers have gotten reamed, but bondholders–the folks who were so confident that negative amortization option ARMs were a great idea that they loaned financial companies hundreds of billions of dollars to make them–are being coddled like babes in the manger.

Why?  The government won’t say.  In fact, the government won’t even publicly acknowledge the issue.  

But the answer, presumably, is that the government is worried about the pain pension funds, insurance companies, and others will sustain if they are actually held accountable for their decisions–and the damage this pain will do to the economy and ordinary Americans.

This damage is probably exaggerated, but before taxpayers are asked to reach into their pockets again, it should at least be discussed.  As should the theory that all these bailouts will actually help the economy recover from this crisis, which some economists say is wishful thinking.

For example, here’s John Hussman:

Fundamentally, my view is that the U.S. economy is on very thin ice, and that by focusing on the bailout of corporate bondholders rather than the restructuring of debt, we are courting the risk of a far deeper downturn. Last year, I didn’t think it was conceivable that policy-makers would attempt to address this problem by making lenders whole with public funds. This is an ethical abomination, putting the public in the position of absorbing the losses that should properly be borne by those who provided capital to these institutions. It is not sustainable. What it does it place the public in the position of losing first, but it will not, and cannot prevent the ultimate failure of the debt – for the simple reason that without restructuring, the debt can’t be serviced.

It is true that insurers, pension funds, and other entities own part of the debt of these financial institutions, but they certainly do not own all of it, and to the extent that it is in the public interest to use public funds to reimburse the losses of various entities, that can and should be part of the political process. But to broadly immunize every bondholder of these institutions with public funds is repulsive. Even the bondholders of Bear Stearns can expect to get 100% of their principal back, with interest…

Until we observe large-scale restructuring of mortgage debt and the debt obligations of major financial institutions, we will be applying trillion dollar band-aids while the underlying cancer metastasizes. The longer we wait to restructure debt, to swap debt for equity, and to expect those who made the loans bear the losses as well, the more we risk allowing this downturn to become uncontrollable and unfathomably costly to the public.

As Harvard historian Niall Ferguson observed last week, “Only somebody who studies financial history could say, as I was trying to say, ‘Look, something as big as the liquidity crisis of 1914 or as big as the banking crisis of 1931 is imminent.’ We don’t really have a great many options here. If we stay the present course, you’re going to see the tailspin continue. To be effective, a large-scale restructuring of household indebtedness would need to be mandatory. The Great Depression was initially a U.S. financial crisis. But what made it a depression was its global contagion, and then the breakdown of trade and the retreat into protectionism. All of that can happen. All of that is in fact happening with terrifying speed.”

Read all of John Hussman’s note >

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