Yes, Of Course Bank Bond Investors Should Absorb Losses!

The first story I read this morning was “Basel Committee Says Bank Bond Investors Should Absorb Losses.”
“The Basel Committee on Banking Supervision is proposing that bond investors should help bear the cost of future bank bailouts as it seeks to reduce moral hazard and the burden on taxpayers. 
All regulatory capital instruments sold by banks should be capable of absorbing losses in the event that a bank is unable to fund itself in the private markets, said the committee, which sets international banking rules, in a consultation document. The securities could either be written off, or converted to common equity, the committee said. 
“A public sector injection of capital needed to avoid the failure of a bank should not protect investors in regulatory capital instruments,” the committee said in the report, published on its website today. 
The committee is seeking to redress the situation during the financial crisis, when holders of Tier 2 capital instruments, such as subordinated debt, benefited alongside depositors from government assistance and avoided losses. The committee is reviewing the role that contingent capital and convertible capital instruments could play in the regulatory capital framework. 
The committee, which represents central banks and regulators in 27 nations and sets capital standards for banks worldwide, was asked by Group of 20 leaders to draft rules after the worst financial crisis since the 1930s. The committee said it will welcome any comments on the proposals until Oct. 1.”
But it’s not just subordinated debt – it’s all debt.  As we’ve said many times – stockholders should get wiped out, bondholders should have their obligations restructured, take haircuts, and become the new equity owners of the company.  I even asked Barney Frank this very question back in May, 2009 at a Town Hall Q&A session – “Why were auto bondholders and shareholders asked to make concessions during their bailout negotiations while bank bondholders and shareholders did not have to make concessions – and how do you justify the massive transfer of wealth from the taxpayer to both bank bondholders, and bank shareholders in the form of common stock dividends which are STILL being paid by Citi and BankAmerica?”

I can’t help but think of the movie Usual Suspects – do you remember the scene where Kevin Pollack’s character (Tom Hockney is being interrogated?):
Cop:  “I can put you in Queens on the night of the hijacking.”
Hockney: “Really?  I live in Queens. Did you put that together yourself, Einstein? What, do you got a team of monkeys working around the clock on this?” 
In other words, it shouldn’t take a committee of central banks and regulators in 27 nations two years to come up with the most obvious solution of all.   But hey – at least it’s a start!

Edit:  Commenter Greycap notes that I misinterpreted this article (which has since been expanded and elaborated on in the Bloomberg link).  His point is that the Basel committee is not talking about who should take the pain in bankruptcy, but rather, how to avoid bankruptcy in the first place by regulating the quality of capital.  So, read this article as a condemnation of the bailouts that subsidized bondholders who should have taken the losses, and not as a condemnation of the Basel Committee taking 2 years to state the obvious – since that’s not what they’re doing here.

-KD

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