Comments on: Stuffing bondholders http://www.creditwritedowns.com/2009/03/stuffing-bondholders.html Finance, Economics and Markets Thu, 09 Feb 2012 21:54:06 +0000 hourly 1 By: Edward Harrison http://www.creditwritedowns.com/2009/03/stuffing-bondholders.html#comment-4287 Edward Harrison Thu, 12 Mar 2009 02:32:41 +0000 http://www.creditwritedowns.com/?p=6967#comment-4287 I would agree that the guarantee should be applied to only solvent institutions. this is one reason that Geithner's stress test needs to be administered quickly. I would agree that the guarantee should be applied to only solvent institutions. this is one reason that Geithner’s stress test needs to be administered quickly.

]]> By: some investor guy http://www.creditwritedowns.com/2009/03/stuffing-bondholders.html#comment-4286 some investor guy Thu, 12 Mar 2009 02:28:41 +0000 http://www.creditwritedowns.com/?p=6967#comment-4286 No! Don't do it! OK. Here's why. A lot of bonds issued by banks are now selling at a very significant discount. You can pick up some Citi bonds for less than 50 cents on the dollar. Giving a blanket guarantee on their bonds would be a massive subsidy to the people who own their bonds. If the bonds are currently trading appropriately for the case where the Federal Government doesn't bail them out, the guarantee would raise bailout costs by at least $100 billion for Citi alone. It would also increase a terrible moral hazard. Both stockholders and bondholders should care about the condition of the companies they invest in. Blanket guarantees create moral hazard. I have a better idea. Guarantee the bonds of the banks you find to be well run and well-capitalized. Private money will flow towards them. Money should always flow toward good management at profitable firms and away from bad management at money-losing firms. If you would like some sort of guarantee to keep firms like Citi from having a liquidity spiral, guarantee the bonds at their most recent prices before the announcement. That would leave bondholders with no writeup or writedown on the bonds. No! Don’t do it!

OK. Here’s why. A lot of bonds issued by banks are now selling at a very significant discount. You can pick up some Citi bonds for less than 50 cents on the dollar. Giving a blanket guarantee on their bonds would be a massive subsidy to the people who own their bonds. If the bonds are currently trading appropriately for the case where the Federal Government doesn’t bail them out, the guarantee would raise bailout costs by at least $100 billion for Citi alone.

It would also increase a terrible moral hazard. Both stockholders and bondholders should care about the condition of the companies they invest in. Blanket guarantees create moral hazard.

I have a better idea. Guarantee the bonds of the banks you find to be well run and well-capitalized. Private money will flow towards them. Money should always flow toward good management at profitable firms and away from bad management at money-losing firms.

If you would like some sort of guarantee to keep firms like Citi from having a liquidity spiral, guarantee the bonds at their most recent prices before the announcement. That would leave bondholders with no writeup or writedown on the bonds.

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