One might think that it should be obvious that elected officials would make sure that all the participants in the profits of a risk taking entity would absorb the losses first, before the tax-payers would be put at risk. But this has not been the case in practice. When financial insolvency has loomed, sometimes stock holders are wiped out (Fannie Mae) but often they have just been diluted (AIG, Citigroup). That equity owners should get a dime if taxpayers are put at risk is troubling enough but they at least absorbed large losses.
The biggest heist comes as financial company bond-holders are made whole when the government is scared or corrupt enough to step in and recapitalize the company without taking the company into receivership. Receivership allows the wiping out of stockholders and bondholders if necessary, while maintaining the functioning of the organization for depositors and counterparties. The very last party that should take a loss is the public, who did not share in profits, bonuses, or bond dividends when the company was doing well. Unfortunately, this is not at all what has happened in practice.
In the US (Fannie Mae, AIG, Bear Stearns and others), UK (Northern Rock), Ireland and recently Spain (with bad assets being consolidated into Bankia), public money has been lost while financial institution bondholders have been made whole. Michael Lewis, financial disaster reporter and author of “The Big Short,” described in an article for Vanity Fair how the government of Ireland put its people on the hook for roughly 50,000 Euros each for the debts of private bondholders:
“The Irish banks, like the big American banks, managed to persuade a lot of people that they were so intertwined with their economy that their failure would bring down a lot of other things, too. But they weren’t, at least not all of them. Anglo Irish Bank had only six branches in Ireland, no A.T.M.’s, and no organic relationship with Irish business except the property developers. It lent money to people to buy land and build: that’s practically all it did. It did this mainly with money it had borrowed from foreigners. It was not, by nature, systemic. It became so only when its losses were made everyone’s
In any case, if the Irish wanted to save their banks, why not guarantee just the deposits? There’s a big difference between depositors and bondholders: depositors can flee. The immediate danger to the banks was that savers who had put money into them would take their money out, and the banks would be without funds. The investors who owned the roughly 80 billion euros of Irish bank bonds, on the other hand, were stuck. They couldn’t take their money out of the bank. And their 80 billion euros very nearly exactly covered the eventual losses inside the Irish banks. These private bondholders didn’t have any right to be made whole by the Irish government. The bondholders didn’t even expect to be made whole by the Irish government. Not long ago I spoke with a former senior Merrill Lynch bond trader who, on September 29, 2008, owned a pile of bonds in one of the Irish banks. He’d already tried to sell them back to the bank for 50 cents on the dollar—that is, he’d offered to take a huge loss, just to get out of them. On the morning of September 30 he awakened to find his bonds worth 100 cents on the dollar. The Irish government had guaranteed them! He couldn’t believe his luck. Across the financial markets this episode repeated itself. People who had made a private bet that went bad, and didn’t expect to be repaid in full, were handed their money back—from the Irish taxpayer
In retrospect, now that the Ir