Today In Bailout-ology

A bailout, in principle, isn’t really THAT horrifying, really. It’s the way bailouts get done that is irritating. And in 2008, financial firms’ bondholders got 100 cents on the dollar to keep everyone out of the bankruptcy courts. That’s unpleasant.

Multiple, simultaneous bankruptcy, the story goes, would have been immensely disruptive; that’s what’s meant by the whole “bring the system down” and “destroy the financial system” and “financial armageddon” thing. I don’t know if the real driving force behind this fear (complexity of these firms’ interconnectedness) has been addressed, but I  know which way I’d bet.

Anyway, the 100% bailout for bondholders of financial firms stands in pale comparison to GM and Chrysler’s (secured) lenders, who apparently took a 71% haircut. Here’s more:

It seems clear that the federal government shouldered out bondholders, who would have received more in a standard bankruptcy procedure, and thus created some uncertainty about how bondholders of other large firms might be treated in the future. On the other side, the UAW retirement funds did much better out of the stage-managed bankruptcy than they probably would have done in a standard bankruptcy. Fiat appears to have gotten a better deal under the stage-managed bankruptcy of Chrysler than it would have received in a standard bankruptcy. The stage-managed bankruptcy did lead to cost-cutting measures like plant closures, fewer employees, and more competitive wages for GM and Chrysler, but presumably these changes would have happened under a standard bankruptcy procedure, too–and perhaps they would have happened in a way that led to greater competitiveness for the firm moving forward.

As a general principle, Uncle Sam is happy to dance around legal precedent (and legal laws?) and screw over bondholders. And there isn’t anything special about individual banks’ bankruptcy, either.

The problem, then, is the interconnectedness of financial firms. No politician has the stomach to let them all get wiped out at once. Nor the stomach to prevent such a crisis in the future.

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