Bondholders and Bailouts: Sharing the Pain

Good comments from a bond ghoul writing in the new Atlantic business channel on the nervousness among his compatriots given that it seems increasingly possible that bondholders will eventually be forced to share the bailout pain. As I have said here repeatedly, PIMCO has made it clear it is taking the other side of that trade, cozying up to the government and even suggesting how it should orient its umbrella of protection. Who is right?

The deepest, darkest concern of bond professionals is whether bond holders of banks will ever be asked to share the bailout pain. Ever since Lehman the Fed's reluctance to impair bank bonds has been palpable. For starters, finance issues represent more than 60% of 1-5 year maturity bonds. They are ubiquitous in pension funds, insurance company portfolios and, until last fall, money market funds (most money market funds have moved up the capital structure to CDs at this point, spooked by the post-Lehman panic). So there are "systemic" reasons to protect them. The same logic protects General Electric. Furthermore, the capital structure of large banks is horribly convoluted. If you wanted to get bondholders to contribute to recapitalization you'd have to create a scheme of cascading discounts to cover preferred stock and capital notes issued by the holding company and the senior and subordinated debt of the banks. Near the top of this stack is the preferred stock investment of TARP, so a bondholder discount necessitates a TARP revaluation. Also, the Guarantied "TLGP" obligations are holding company debt and would have to be discounted. So the government would participate in any loss.

Still, one understand public sentiment on this issue. Apart from Lehman, bondholders, like CDS counterparties, have benefited at the expense of taxpayers. This potential uncertainty is one of the things supporting wide bond spreads. Despite the obvious government support, Citibank's holding company bonds offer a plus-sized 5% premium over their government-guarantied paper. Pimco, the gorillas of bond investing have publicly positioned themselves as if this pain-sharing will never happen. "Shake hands with the Government", they claim. Others among us have hedged our bets. On Tuesday, Geithner will choose where to locate losses, or delay the reckoning again.

More here.

Comments

[Harry Tuttle:]

Geithner is still trying to save the equity holders. There is a long way from there to the senior debt.

Feb 09 12:34 PM

[Macro:]

"Partner with the government" = Front run the government and hide behind the taxpayer to shoulder all the losses.

Greetings from Pimpco Bill

Feb 09 12:55 PM

[Macro:]

Partner with the government -> Hide behind the taxpayer and let them shoulder all the losses (like Warren Buffett in GE and WFC)

Bill Gross the PIMPCO man

Feb 09 12:56 PM

[Stock Marke...:]

Agreed...Bill Gross is always painted with horns and pitchfork while Buffett the angel does the same thing..just not on CNBC videos.

Feb 09 01:28 PM

[Emerald:]

Yes, Bill Gross may be front running his portfolio and has an insider's hand as an advisor to the government. So what. As an investor, perhaps you should play his game and invest accordingly. I would suggest Bill and Warren are reasonably transparent about it. If you can't make the rules according to your personal economic philosophy, then invest with the wind at your back.

Feb 09 02:28 PM

[Macro:]

Of course, anybody would like to invest on the same terms as Warren Buffet. But you miss my point. Low income tax payers are not able to and they are the guys shouldering the economic cost for paying WFCs dividends and Pimpco's performance bonuses. Fair and true captalism right?


On Feb 09 02:28 PM Emerald wrote:

> Yes, Bill Gross may be front running his portfolio and has an insider's
> hand as an advisor to the government. So what. As an investor, perhaps
> you should play his game and invest accordingly. I would suggest
> Bill and Warren are reasonably transparent about it. If you can't
> make the rules according to your personal economic philosophy, then
> invest with the wind at your back.

Feb 09 02:39 PM