Should Bondholders be Bailed Out?

So what bailed you in?

I've bailed out friends in need before.

You were bailed out of detention barracks.

You ever bailed out of one of these planes before?

Yes, my plane was shot down, and I bailed out.

We investigate and prove his alibi... but before anybody knows that except us, he's bailed out.

It was blown off too close to put on a tourniquet so I bailed him out.

CAMBRIDGE A year after the United States government allowed the investment bank Lehman Brothers to fail but then bailed out AIG, and after governments around the world bailed out many other banks, key question remains when and how should authorities rescue financial institutions?

It has retreated from them since it nearly collapsed eight years ago and had to be bailed out.

They responded that they had not rescued the truly bad speculative actor, Russia that they had bailed in, not bailed out, the New York banks, by requiring them to cough up additional money to support South Korea s economy and that everyone had benefited massively, because a global recession was avoided.

But, while these considerations provide a basis for providing full protection to depositors and other depositor like creditors when a financial institution is bailed out, they do not justify extending such protection to bondholders.

The opposition underestimates the Kirchners achievements, arguing that the international context, particularly high commodity prices and thus strong export revenues bailed them out. While that is true, high export prices alone were no guarantee for success.

We gritted our teeth and for the sake of our national economies supported our governments as they bailed out the banks with public money. It was a necessary, if infuriating, act of salvation to avoid economic disaster.

Although Greece was bailed out a year ago, Plan A has now clearly failed. Greece will require another official bailout or a bail in of private creditors, an option that is fueling heated disagreement among European policymakers.

But, contrary to populist rhetoric, it is not just rich, well connected bondholders who get bailed out. Many small savers place their savings in so called money market funds that pay a premium over ordinary federally insured deposits.

In contrast to the recent rash of bailouts, future government bailouts should protect only some creditors of a bailed out institution. In particular, the government s safety net should never be extended to include the bondholders of such institutions.

Then there are the countries including Venezuela, Argentina, and Russia that never moved in the reform direction in the first place. They were temporarily bailed out by strong world prices for their export commodities, but that ended last year.

In 2008, Germany rescued Hypo Real Estate, and in 2011 Belgium, France, and Luxembourg bailed out Dexia Bank. As these cases suggest, cleaning one s own porch could have been done without much of a fuss, or at least without stoking international tension.

Who bailed out the banks, pumped in the liquidity, engaged in fiscal stimulus, and provided the safety nets for the unemployed to thwart an escalating catastrophe? Who is re writing the rules on financial market supervision and regulation to prevent another occurrence?

Forcing a debt for equity swap or debt forgiveness would be no greater a violation of private property rights than a massive bailout. But, for the major players in the financial sector, it is much more appealing to be bailed out by the taxpayers.

They can undertake risks that others cannot, knowing that if they fail, they may be bailed out. While one can understand the domestic political imperatives that have led to subsidies and guarantees, developed countries need to recognize the global consequences, and provide compensatory assistance to developing countries.

MUNICH With pain and misgiving, the United States Congress bailed out Wall Street in order to prevent a meltdown of America s financial system. But the 700 billion to be used may flow into a leaky bucket, and so may the billions provided by governments throughout the world.

Second, much of the financing for Greece s debts came from German and French banks that earned huge profits by intermediating loans from their own countries and from Asia. They poured this money into a fragile state whose fiscal credibility ultimately rested on being bailed out by other euro members.

Huge stimulus packages were implemented in 2008 9, led by the United States and China, coordinated by Britain, and with the reluctant support of Germany. Interest rates were slashed, insolvent banks were bailed out, the printing presses were turned on, taxes were cut, and public spending was boosted.

Yet a critical moment in the crisis came when, shortly after the mid September 2008 collapse of Lehman Brothers, a money market fund broke the buck and couldn t pay 100 cents on the dollar. Of course, it was bailed out along with all the other money market funds.

And such requirements would reduce the likelihood that strong banks would be called upon to finance the resolution of failed institutions. (Of course, these considerations are less relevant if bankers expect to succeed in blocking all regulation aimed at reducing excessive risk taking, and to be bailed out in a crisis.)

Now, however, the US government can say none of these things. Officials cannot say that a global recession has been avoided that they bailed in the banks that with the exception of Lehman Brothers and Bear Stearns they forced the bad speculative actors into bankruptcy or that the government made money on the deal.

Of course, before being bailed out by governments, banks had never made any return in their history, assuming that their assets are properly marked to market. Nor should they produce any return in the long run, as their business model remains identical to what it was before, with only cosmetic modifications concerning trading risks.

Financing in continental Europe is traditionally bank based, unlike in the US, where capital markets reign supreme. But banks are being told by regulators to reduce their leverage and to post higher capital when they embark on risky lending, and their creditors are being told that they should not expect to be bailed out if banks get into trouble.

Then came the financial crisis, which cost millions of Americans their jobs and homes. When unemployment insurance, designed for short term bouts of joblessness in a full employment world, ran out, they were left to fend for themselves, with no safety net (beyond food stamps), while the government bailed out the banks that had caused the crisis.

The crisis started with too much private debt and leverage, which became public debt and deficits as crisis and recession triggered fiscal deterioration and private losses were mostly socialized via bailouts of financial systems. Then, distressed sovereigns that had already lost market access Greece and Ireland were bailed out by the International Monetary Fund and the European Union.

If such a contingent capital structure had been in place before the crisis, troubled banks would have been recapitalized by the contingent debt holders while avoiding the complications and legal posturing inevitable in formal bankruptcy. Debt investors, not the government, would have bailed out the banks, making the financial crisis substantially smaller, if it had occurred at all.

On the downside, one of the most important risks is further financial contagion in Europe if the eurozone s problems spread as seems likely to Portugal, Spain, and Belgium. Given the current level of official resources at the disposal of the International Monetary Fund and the European Union, Spain now seems too big to fail yet too big to be bailed out.

Historians will argue whether forcing Lehman Brothers into bankruptcy in September 2008 precipitated the subsequent global financial crisis. Vincent Reinhart, formerly of the US Federal Reserve and now at Morgan Stanley, has argued that the Lehman decision was correct (the error came earlier, with the bailout of Bear Stearns, which created an expectation that all banks would be bailed out).

During the financial crisis, it was national governments that bailed out banks and firms, recapitalized the financial system, guaranteed debts, eased liquidity, primed the fiscal pump, and paid the unemployment and welfare checks and took the blame for everything that went wrong. In the memorable words of outgoing Bank of England Governor Mervyn King, global banks are international in life, but national in death.

Where the Obama administration went wrong was in how it bailed out the banking system it helped banks earn their way out of a hole by purchasing some of their bad assets and supplying them with cheap money. This, too, was guided by political considerations it would have been more efficient to inject new equity into the banks, but Obama feared accusations of nationalization and socialism.

If the government had not bailed out large banks, the insurance giant AIG, and the auto industry, and if the Federal Reserve had not flooded the economy with liquidity, the wealth of the super rich would have taken a severe blow. Many argued that the government should have focused on rescuing homeowners instead, the government chose to support the banks a policy from which the financial elite benefited the most.

There are many reasons for this political earthquake, but the biggest are the enduring misery of depressed living standards, double digit unemployment rates, and diminished hopes for the future. Europe s rolling crisis has shredded trust in the competence and motives of policymakers, who failed to prevent it, have so far failed to resolve it, and bailed out banks and their creditors while inflicting pain on voters (but not on themselves).

Merkel, together with the European Commission and the European Central Bank, threatened to deprive Greeks of the use of their own currency, the euro, unless their government accepted punitive conditions. Greeks have been forced to accept brutal austerity measures in order to continue to service an unbearable debt burden, thereby limiting losses for French and German banks and for eurozone taxpayers whose loans to Greece bailed out those banks.

Hamilton made the case that the federal government should assume responsibility for their liabilities stemming from the costs of financing the war. He identified a source of revenue the tariff that could be devoted to this end, and he rendered the bargain politically palatable by making clear that if state governments accumulated additional debts, and again got into trouble, they would not be bailed out a second time.

In 2008, when the Landesbanks were found to be full of American subprime mortgages, the German government bailed them out with a 500 billion ( 650 billion) rescue package at its taxpayers expense. In 2010, when German banks were badly over exposed to the tune of 704 billion to Greece, Ireland, Italy, Portugal, and Spain, European taxpayers and the ECB helped them to bring most of that money home.

Spain s protesters, and those in other countries, are right to be indignant here is a system in which the bankers got bailed out, while those whom they preyed upon have been left to fend for themselves. Worse, the bankers are now back at their desks, earning bonuses that amount to more than most workers hope to earn in a lifetime, while young people who studied hard and played by the rules see no prospects for fulfilling employment.