From TPM Reader RB …
I’m glad to see TPM picking up on the question of what is to be done about the bondholders. I’ve had the feeling for a few weeks that this is the real Gordian knot the Administration can’t bring itself to cut, for fear that the rope is holding up the roof above all of us.
Here’s my next question, though: aren’t most of those bondholders holding not traditional bonds – straight debt from straight borrowing at whatever interest – but derivatives of and bets on those traditional bonds? And that being so, wouldn’t government, once the banks went into receivership, be able to institute rules that make holders of “real” bonds whole, and pay off the derivative gamblers at pennies on the dollar?
And if that in turn is so, doesn’t every day the government fails to bite the bullet mean another bunch of billions paid back out of taxpayer funds to the derivative gamblers rather than the institutions that made good faith investments?
With all the conversations I’ve had today, when I get questions like this, I’m tempted to reply: “You got me. No idea.” What’s far more troubling to me, though, is that I talked to a few world-renowned economists today who said pretty much the same thing to me when I asked them some of these questions.
I’ve been increasingly mystified and frustrated, bordering on angry, over recent days as I realized that the assumption behind all the would-be financial sector fixes is that the bondholders — i.e., the creditors of the big financial institutions, the folks who lent them money — should take at most a nominal hit, even though they lent money to companies that in every real sense of the word went bankrupt. And the money to pay them off has to come from American taxpayers.
I was expected to hear some basic skepticism about this assumption from the economists I spoke to. But I didn’t. They agreed that the danger was just too great, notwithstanding the unfairness to the taxpayer. And most of the fear stems back to what happened to the global credit markets after the collapse of Lehman Brothers last fall.
Now, as to RB’s point, I think he’s got a big part of the equation right. Having the bondholders take a substantial hit seems too scary to contemplate to these folks. The amount of money you’d need to make everyone whole just looks politically unfeasible. So it’s very hard to know just where to go.
What it all amounts to is that the bondholders have a gun to the head of the world economy. But it’s a real gun. And it may be loaded.
Who knows …
