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Wrong moral hazard focus on stock holders

by Martin Sat Sep 27th, 2008 at 08:27:29 PM EST

In the discussion about rescue plans for the financial crisis, there is quite some focus on not producing moral hazard by buying out stockholders, but there are other stakeholders, who can make dumb decisions, on which there is no focus.


The people owing the stocks have made a lousy investment, when having bought them a couple of years ago. Even when the companies are kept solvent, the bubble game hasn't worked out for them.

The real profiteers are the bankers. Many had salaries, which they couldn't get in years, if they would not have been allowed to take enormous risk. Because a one-year good performance gave them a bonus, not of a fraction, but multiple times their fixed salary. It is impossible to take that money away from them, but that's not a reason to shift prime responsibility elsewhere. CEOs and top managers are very powerful in modern companies, especially when their short term results are OK.

The other people, who did get a better deal than stock holders, are the bond holders. But why should they be bailed out, when it is wrong to bail out the stock holders? When you require a stock holder to check exactly, what he buys, then why should bond holders not be required to check exactly? Still any bail out plan (and past bail outs of F&F, BS, AIG) did not ask bond holders for an haircut.

Only the 'Industrial Bank of America' plan will produce more or less fair results with distributing losses between stock holders and bond holders.

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I have also been struck by how people have enphasised the need for shareholders to lose out (and they indeed have in most of the bailouts), but how little has been said about the bondholders.

Maybe the dirty secret is that this is about protecting the assets held by the Chinese, and thus their willingness to keep on lending...

As to bankers' remunerations, that has been discussed, but with no conclusive solution.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Sun Sep 28th, 2008 at 06:18:41 AM EST
The cross border exposure on all this is amazing.  Even the Caja Laboral, Mondragon's in house bank in Spain, has $162 million in exposure through ownership in a Lehman subsidiary in the Netherlands.  And US failures are starting to pull down European banks.  Like Fortis.

And Barclay's bank has a 95 million share stake in AIG that's lost almost 90% of its value in not so many days.  That's a $2 billion loss, something like half of gross second quarter earnings.

The contagion is spreading.  It looks like the Anglo disease may be a global epidemic at this point.....    

And I'll give my consent to any government that does not deny a man a living wage-Billy Bragg

by ManfromMiddletown (manfrommiddletown at lycos dot com) on Sun Sep 28th, 2008 at 04:37:04 PM EST
[ Parent ]
Paulson, it should be noted, is very very close to the leadership in Beijing, from his GS days (Goldman Sachs did quite well in China the past decade).

There are dots here to connect but, of course, few journalists qualified to connect them.

The Hun is always either at your throat or at your feet. Winston Churchill

by r------ on Mon Sep 29th, 2008 at 03:56:33 AM EST
[ Parent ]
I have seen suggestions in the US financial press, (can't remember where,) that bond holders at least be given a hair cut when things go really bad.  Then they might be more circumspect in whose bonds they buy.  But the prime difference between stocks and bonds is that you are supposed to know the duration and rate of return on bonds held to maturity, unless they are reverse convertables or such.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sun Sep 28th, 2008 at 02:03:46 PM EST
But with a haircut to reduce the gain to the level of US Treasuries of the same maturity, e.g. what they could have gained in a risk free investment, wouldn't even be a neutral, but still good for the bond holders.

It has turned out, that they got a risk premium, without that there was a risk, as now, as the risk strikes, there is a bail out.

So if everything goes fine, you get the risk premium, if there is a problem you get the same as if you never had taken a risk, this is still a free lunch out of the others pocket. And that is not even what happend or what is planned in the next bail out.

In case of F&F there was all the time only a small risk premium, because a gov't bail out, was pretty expected, but e.g. AIG bond holders (and CDO insurance buyers) did get a big free lunch.

In the end, there was already critisism, that the gov't wiped out preferred shares in F&F, as this would have been the best bet for recapitalisation of small banks across the US, but now nobody wants to sink his money into a potentially insolvent company. To keep at least this channel open, the bond holder bail out, might have been reasonable, even with the other companies, but the best thing would be transparency, which companies are fundamentally sound, and which aren't, and the hand out of free lunches is annoying.

Der Amerikaner ist die Orchidee unter den Menschen
Volker Pispers

by Martin (weiser.mensch(at)googlemail.com) on Sun Sep 28th, 2008 at 02:18:35 PM EST
[ Parent ]
It has turned out, that they got a risk premium, without that there was a risk, as now, as the risk strikes, there is a bail out.
Hence the justification for at least a 10% haircut to bond holders.  They would still make out better than stock holders.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sun Sep 28th, 2008 at 03:25:37 PM EST
[ Parent ]
Hypo RE is under pressure. They have lots of long term committments and finance it in the very short term (link).
The recent turmoil has increased the costs of short term lending so much, that they can't refinance profitable any more.

In this post Paul Krugman explains, why reducing interest rates to very close to zero is a bad idea. At least here European countries still have munition, given the ECB rate at 4.25%, and the interest of the Bank of England even higher. In the next months I would expect the ECB to cut rather strongly, if the turmoil continues.

Der Amerikaner ist die Orchidee unter den Menschen
Volker Pispers

by Martin (weiser.mensch(at)googlemail.com) on Sun Sep 28th, 2008 at 07:03:49 PM EST
One way to eliminate moral hazard on the part of the bankers: throw a few of them in jail and start expropriating assets to help pay for the damage they've done.

It won't happen now...one of those very same bankers is at the head of Treasury pushing on the bailout of which we speak.

But if things get bad (and they likely will) we may start seeing some interesting things though given the nature of power in the US this will likely mean one faction of oligarchs (perhaps from the real economy, the automakers, the airlines or other struggling bits of the US industrial bqse) goes after the other in the financial sector.

Could make for interesting times. To be watched from afar.

The Hun is always either at your throat or at your feet. Winston Churchill

by r------ on Mon Sep 29th, 2008 at 04:00:09 AM EST
throw a few of them in jail and start expropriating assets to help pay for the damage they've done.

As I've said before, we could call the crime "financial treason".

Could make for interesting times. To be watched from afar.

Indeed.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Mon Oct 6th, 2008 at 10:45:07 AM EST
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