Bailouts
A friend and I met up tonight, and over some drinks we were in heated agreement over how governments have not been dealing with failed institutions properly, be they automobile manufacturers, insurance companies, or banks.
My solution is for the government to be a DIP (debtor in possession) lender only. No ownership of equity, no protection for equityholders or bondholders, just protection of the operating business. So the government cash infusion would be enough to guarantee banks’ deposits, swaps and other contracts (except executive compensation, I’d probably reject those because you shouldn’t get paid for driving a company into the ground), but not any subordinated debt, and certainly not equity. Then the business would work its way through reorganization, and have an initial public offering. The new cash would first pay the government its principal and interest, as it’s the most senior lender, then the secured lenders, and anything left over would pay subordinated debt—and if by some miracle money was left beyond that—and prior equity holders. This is how restructuring works when the government isn’t injecting money, and it should be how it works when it does.
These bailouts of bond and equity holders (see Ireland, this week) are such a misuse of money. For example, why do the shares of the Bank of Ireland have any value? Restructure it and wipe them out!
The institutions would be stronger, and more useful to society, if they were restructured properly. If other companies face a crisis of confidence and go under, let them, the government can step in as many times as necessary - because it will always be repaid in full. The only people who get hurt are investors, and that’s all in the game.
