Garett Jones  

TARP: A Gift for the Bondholders

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When the federal government bought shares in the biggest banks, who benefited most: Shareholders or bondholders?  

According to co-blogger Luigi Zingales and U Chicago professor Pietro Veronesi, the answer is clear: bondholders. They estimate the total benefit to banks at $131 billion, and 

the total increase in debt value due to the plan at $119bn. 

So by their estimate over 90% of the benefit to banks' balance sheets went to bondholders. [As a special bonus, the authors also estimate the bailout's cost to taxpayers.]

If most political battles need a villain to succeed, it's easy to see why bondholders have largely escaped the wrath of voters: Bondholders make poor villains.  The bank promised to repay, and now the bank can't.  The bondholder wasn't out there making the loans; the bondholder didn't vote for the directors who led the company to the brink of destruction; the bondholder just handed some cash to the bank and hoped for the best.  

Bondholders have had good luck getting government guarantees, and I suspect their luck will continue.  That means rational investors will dump more cash into the megabanks with minimal scrutiny: The megabanks are the new Fannie and Freddie.  

Here's hoping I'm wrong.  

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CATEGORIES: Finance



COMMENTS (5 to date)
Methinks writes:

I can hope you're wrong but I learned decades ago that if I'm hoping and praying, I'm in a bad trade.

Creditors of the banks are themselves political cronies who make a big public show of predicting terrifying potential consequences of not getting repaid for the trembling population they're trying to mug. So much better when the victims help you rob them!

Joe Cushing writes:

I'm sure you are not wrong. In a free market the lender has a great responsibility to underwrite loans. I don't believe we should feel special sympathy for them if the loans go bad vs if stockholder loose. They have as much responsibility as the shareholders. Without lenders, the boards that shareholders vote in, would not have been able to do the things they did.

Greg G writes:

Yup. Sadly, you are right here Garett. I am an outside director at a small community bank. We are very conservative, extremely well capitalized and never made a bad loan during the housing bubble. We would have survived without any bailouts but our balance sheet would have taken a big hit. Almost every bond we held would have had a lower market value.

When I made this point to our board and said that we needed to view ourselves as big beneficiaries of the bailout they looked at me like I was from another planet. "But we didn't make those bad loans. All we did was buy AAA bonds. We weren't the problem." they said.

It is true we weren't the problem. But it is a big problem that we still don't know we were among the big beneficiaries of the bailouts.

tmc writes:

So we spent $25-$47 billion to avert a probable crisis that would have a lot of additional consequences. The benefit to the bondholders is an afterthought, not unlike my neighbors benefitting from me maintaining my house.

As a side note, how does the accounting of this go? Bush gets the cost of the bailout assigned to him, as the money was spend under him. Does this get subtracted from his debt when the 90% (?) of tarp gets paid back? or does Obama get the windfall?

Mr. Econotarian writes:
So we spent $25-$47 billion to avert a probable crisis that would have a lot of additional consequences.

Or perhaps the moral hazard of banks expecting this bailout from the government was the CAUSE of the housing bubble and associated recession (which had significant additional consequences).

And even if you don't believe that, perhaps the moral hazard of the bailouts will encourage future bad behavior by banks causing future significant additional negative consequences...

(file this under "seen and unseen")

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