Will Bondholders Ever Share In Banking Losses?


Whatever the final details of the banking bailout look like, we know the basic equation will be something like: taxpayers screwed, shareholders and bondholders remain intact. Thus we’ve seen this plan described as the PIMCO Bailout, since the bond management firm has made a point of betting on the fact that government will protect them.

So is there any chance that Bill Gross & Co. could get screwed, and asked to take a share of the pain? Over at The Atlantic (via Paul K), the pseudonymous Mindles H. Dreck says there’s still a fear among some that they might:

The deepest, darkest concern of bond professionals is whether bond holders of banks will ever be asked to share the bailout pain.  Ever since Lehman the Fed’s reluctance to impair bank bonds has been palpable.  For starters, finance issues represent more than 60% of 1-5 year maturity bonds.  They are ubiquitous in pension funds, insurance company portfolios and, until last fall, money market funds (most money market funds have moved up the capital structure to CDs at this point, spooked by the post-Lehman panic).  So there are “systemic” reasons to protect them.  The same logic protects General Electric.  Furthermore, the capital structure of large banks is horribly convoluted.  If you wanted to get bondholders to contribute to recapitalization you’d have to create a scheme of cascading discounts to cover preferred stock and capital notes issued by the holding company and the senior and subordinated debt of the banks.  Near the top of this stack is the preferred stock investment of TARP, so a bondholder discount necessitates a TARP revaluation.  Also, the Guarantied “TLGP” obligations are holding company debt and would have to be discounted.  So the government would participate in any loss.

Still, one understands public sentiment on this issue. Apart from Lehman, bondholders, like trading counterparties, have benefited at the expense of taxpayers.   This potential uncertainty is one of the things supporting wide bond spreads.  Despite the obvious government support, Citibank’s holding company bonds offer a plus-sized 5% premium over their government-guarantied paper.

Politicians are helped by the fact that the bond market is largely invisible, at least compared to the stock market. When a stock soars on a bailout, it gets reported on widely and taxpayers can see that their money went to help this or that particular corporation. The bond market, for whatever reason, doesn’t get the same play. Not nearly. So when the taxpayer gets hosed to line Bill Gross’ pockets, that’s not something understood outside of a small circle of observers.