the visible hand

it is the theory which decides what can be observed – einstein

credit defaults and reorganization

Posted by ecoshift on May 9, 2009

As I watch events unfold I remain puzzled by the apparent commitment (by former free market advocates) to devote copious amounts of taxpayer funds to recapitalization of failing banking and investment management institutions. I thought risk was the reason for all the rewards of past years. The risk of negative outcomes. Like the ones we are experiencing right now.

Instead it appears bondholders have the country by the short hairs. In the videos below both Joseph Stiglitz and Bill Ackman provide clear rationale for forcing bondholders into debt for equity swaps through bankruptcy or other reorganization proceedings. The debt would disappear and toxic assets currently on the balance sheet could avoid sale into distressed markets — thereby recovering their full real value over time whatever that value turns out to be. Of course bondholders resist moving from their current secured debtor status to a risk sharing equity status. Yet the value of the collateral that provides that “security” would ordinarily be recovered through liquidation sales into distressed markets — clearly not a way to get a full dollar back on the nominal value of the debt they hold — unless they agree to proposed reorganization scenarios.

So I’m thinking to myself that someone should play a tape loop of JP Morgan buying stocks into the crash of ’29 in order to stop wholesale panic and destruction of financial markets until the bondholders get the message: we, the people of the United States, the people of the global economy and the small-enough-to-fail businesses that provide the majority of the jobs, innovation and markets in the real economy – the economy that feeds the returns enjoyed by financial elites: we need you – the financial elite – to step forward, take this haircut, and share our risks going forward. Your willingness to do this will put you in a controlling position in a stable if not growing economy. Your failure to do this will leave you king of the hill on moldering zombie economy that ensures the continued degradation of all of your assets. Sure we can print up enough money to make you whole, but it’s only going to put the dollar into a tailspin — decreasing the value of your holdings. More than that – it’s just the right thing to do. You reaped the profits of the bubble. So you can justify your gains now by providing a much needed service to the nation—the forgiveness of debt and the assumption of risk.

But I forgot about the credit default swaps. I mean we already bailed out AIG and lost our leverage. As noted below: if bondholder debt is insured by CDS they are in a very strong negotiating position: make us whole – or we scuttle effective reorganization… and still get paid.

Ah, capitalism. Risk is only for governments and taxpayers — not for the smartest guys in the room.


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