AlphaNinja - While it may seem a bit late to discuss bank bailouts, we're going to have many more on our hands in the months and years ahead. I thought I'd share two very smart opinions of how to deal with "failed banks."
Thomas. M Hoenig wants us to avoid the mistakes Japan made in elongating their bank pain. He suggests models like Sweden used, and the US back in the day.
Maybe the most reasonable suggestion yet comes from John Hussman of Hussman Funds. This piece is from back in March of this year. He points out that the government rushes in with taxpayer money because banks are in danger of becoming "insolvent." But this definition of insolvency simply includes equity (stockholders). He points out that bank debtholders should be on the hook too, as they're simply speculators higher up the capital structure (paid back first in a liquidation). We the taxpayer have effectively been paying to prevent bondholders from suffering losses.
From the beginning of the recent crisis, starting with Bear Stearns, I have emphasized that nearly all of the financial institutions at risk of insolvency have enough liabilities to their own bondholders to fully absorb all probable losses without any loss to customers or the American public. The sum total of the policy responses to this crisis has been to defend the bondholders of distressed financial institutions at public expense.
Note that in the example balance sheet above, 30% of the liabilities of the institution represent debt to the company's own bondholders. It is these individuals – not homeowners, not the American public – that are being defended by the promise of trillions of dollars in public money.
For example, while Citigroup has approximately $2 trillion in assets, those assets are financed not only by customer deposits, but also by nearly $600 billion in debt to Citigroup's own bondholders. It is these private bondholders who provided the funds for Citigroup to acquire questionable assets.
The bondholders of distressed financial institutions – not the American public – should bear responsibility for the losses of those institutions.