A Good Time to Hold Bonds (NY Times)

April 6, 2009
Breakingviews.com
Good Time to Be a Bondholder

Bank bondholders around the world can probably breathe a sigh of relief. Ever since Lehman Brothers went bankrupt, leaving bondholders with losses estimated at north of $100 billion, they have lived in fear of another wipeout.

For example, Citigroup’s subordinated debt issues — whose claims would rank below those of more senior lenders in a bankruptcy — trade as low as about two-thirds of face value. But further pain is unlikely because the Group of 20 leaders seem determined to bail out bondholders if needed.

The G-20 hasn’t spelled this out. But it’s implied in a paper drawn up by the finance ministers. The authorities fear the effects of more bank debt defaults. In particular, they worry that such defaults could undermine the solvency of insurerss, which are big owners of subordinated bank debt.

The G-20 finance ministers last month said shareholders should be allowed to suffer when banks are bailed out. But they pointedly omitted any reference to bondholders.

Theoretically, the G-20 could still impose pain on bondholders. But several government officials said there was no appetite for this after the damage from Lehman, and to a lesser extent, the failures at Washington Mutual and Bradford & Bingley of Britain.

But doesn’t this make a joke of the whole bank capital regime? For years, banks have been issuing subordinated bonds and bond-stock hybrids with the idea that such instruments can, to varying extents, count as part of their capital cushions. If governments aren’t going to let bondholders suffer any losses in a crisis, then subordinated debt at least shouldn’t go toward risk capital.

The authorities do understand that banks can’t be allowed to have it both ways. That’s why subordinated debt is unlikely to count as capital in the future.

Again, the G-20 hasn’t quite said this. But the small print of the group’s communiqué last week did say that the “quality of capital should be enhanced.” One of the officials said it’s likely that only common and preferred shares would make the grade.

So subordinated debt most likely won’t be so useful for banks. But bondholders can probably count themselves lucky.

HUGO DIXON and JOHN FOLEY

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