Ireland is showing us exactly how not to do it. It's instructive to compare that with Iceland (the country, not the supermarket), who were/are in a similar mess following the bursting of the credit bubble. They made the best of a bad job and:
a) Resisted the siren calls (i.e. blunt threats) of the EU.
b) Told the bond holders in Icelandic banks to get stuffed. Very briefly, they ranked ordinary depositors ahead of bond holders, so the little people got their money back and bond holders got very little. That includes a lot of UK local councils, so that's our money we're losing, but hey; we can take all the stupid local council finance guys to court for misuse of public funds, but short of invading, there's not much we can do about the con artists in Iceland; that's up to the Icelandic government to sort out.
The article also mentions that "creditors took control of Straumur, the fourth-largest Icelandic bank", which is another way of describing a debt-for-equity swap, and is the normal way of dealing with these situations.
The eternal generality
15 minutes ago
27 comments:
I agree. Good for Iceland if they refuse the UK government's gunboat diplomacy.
Dont kid yourself Mark, the eurotwats will not give up their dreams without a fight, the Irish can go live in a bin and eat mud first, will be their calculation.
In the meantime the German and French banks that bought the bonds on the back of the eurotwats sayso need to be saved.
TT, it's true that Iceland got one over the long-suffering British council tax payer; but the UK could (if it wished) get a much larger one over a lot of other people. That's my dream and I'm sticking to it.
S, they will not give up without a fight, but in a week when Merkel and Rumpy both admit that the ill-fated Euro-zone is the glue that holds the even shakier EU together, you get the feeling that they are indeed running scared. That's my dream etc.
I'm not up to speed with Icelandic law, however, in Ireland it would be illegal to treat account holders as senior to senior bank debt holders.
I don't understand how anyone can logically support changing the rules of the game arbitarily after the fact to buy votes with OPM.
BR, it's not in the rules of the game for banks to lend as recklessly as they did either. They changed the game, the government changed the rules.
Either way, had the government decided to bail out the bondholders with taxpayers' money, that's changing the rules as well, isn't it?
Lets be specific, bailing out bank creditors.
What you're arguing is that a government should retrospectively change the law, which is different from purchasing equity in the Irish banks, something which is legal. Savers that left their money in reckless institutions to earn slightly higher interest were just as foolish as any lending decision made by the banks.
Effectively you're saying property rights should be dependent on the assumed wealth or institutional position of the holder?
BR: "Savers that left their money in reckless institutions to earn slightly higher interest were just as foolish as any lending decision made by the banks."
Agreed. When I have ever said anything else?
"What you're arguing is that a government should retrospectively change the law"
I'm not, actually. I'm old fashioned and say that debts should be paid as they fall due. So an ordinary depositor can withdraw his money any time he likes so he gets repaid first, a bondholder with a ten year bond has to get to the back of the line.
"Effectively you're saying property rights should be dependent on the assumed wealth or institutional position of the holder?"
Nope. When did I ever say this? I'm old fashioned about this as well.
Debts get repaid in the order they were agreed to be repaid. And if there's not enough left over for the bondholders then TOUGH SHIT.
I am surprised that you are so sanguine about YOUR taxpayer's money being used to compensate the losses or people who are far richer and/or better informed than you and who willingly took on certain risks and rewards.
It may be, for example, that a load of little mugs have entrusted their £10,000 life savings to a huge pension fund who invests in bank bonds, but all the deposits are held by wealthy, canny, cautious investors with £1 million each. Depositors get priority
It may conversely be that the cautious little people put their £10,000 life savings on deposit and the bonds are owned by super wealthy. Depositors get priority.
Can you see a pattern emerging here?
The point is that depositors get repaid first, that is the natural order of things. Once a bank has difficulty meeting its creditors, it can no longer function properly as a bank and the internal rules of the bank are absolutely irrelevant in the insolvency courts.
"So an ordinary depositor can withdraw his money any time he likes so he gets repaid first, a bondholder with a ten year bond has to get to the back of the line."
Well this probably the error. As a depositor you're not at the front of the queue. Maturity of debt doesn't determine seniority of claims, either legally or logically.
I've been involved in plenty of reorganizations, debt for equity swaps and chapter 11 proceedings. You can't just throw away the seniority of claims and now say it should be done on maturity of debt.
BR, aha, so what you are saying is that if the bondholders think things are getting iffy, they can just shut the bank doors and tell the depositors that they can no longer withdraw money for the next ten years until all the bonds have been redeemed?
You don't count that as 'changing the rules', do you?
Besides we are getting off the subject. The subject is
a) that Iceland are making a much better fist of this than Ireland.
b) in the UK there is an explicit government guarantee for deposits up to £50,000 (used to be up to £50,000). There is no such guarantee for bonds. Why on earth should taxpayers money be used to bail out bond holders when a debt for equity swap would suffice?
No its not bondholders that shut the doors. Its the responsibility of regulators and management to put the firm into bankrupcy when they realize they are insolvent. Then who gets what in liquidation is determined by credit seniority, which is NOT the same as maturity.
For example if you have an overdraft and a mortgage, and you go bust, does because the overdraft can be called in sooner than the mortgage mean that it ranks as the most senior claim against your assets?
a) I disagree, I think Iceland is a disgrace.
b) Fine, depositors can make a claim against the government for any shortfall they would have had once assets had been liquidated and properly divided amongst the different creditors.
Not that allowing these institutions to be put into liquidation would have benefitted the taxpayer.
BR, you can say what you like, but AFAIAC, once a bank has lost the faith of its depositors, it is all over.
Then, because banks are a special case and regulated or supervised by the government to a far greater degree than any other, it is a question of deciding how assets get divided by between OWNERS of the bank and CREDITORS of the bank, with the government as referee.
It might be different in the USA than in the UK, but as a general rule, CREDITORS of a business are paid before the OWNERS in our Company Law or Insolvency Law.
In my world view, depositors are CREDITORS of a bank and bondholders are OWNERS of a bank (although the legal position if you plough through reams of paperwork is not so clear cut). Ergo, depositors get repaid in priority.
If we take it to extremes, all bank bonds could have a little clause in six point type on page 497 saying "In the event of a bank run, these bonds will be entitled to 100% interest per day compound to rank before depositors".
As you cannot reasonably expect ordinary depositors, who might choose a bank simply because it is conveniently situate near their home or their place of work to read the terms and conditions of every single bond that the bank has ever issued, I fail to see how such terms can be enforced on them.
No, I'm sorry that is just wrong.
A bondholder is a creditor, its not a matter of interpretation, its what the word means!
A bondholder has lent money to a bank, it is NOT an owner and in no way will participate in the banks profits like a shareholder.
In the example of your "extreme", that couldn't be the case, because then the bonds would have to be issued as a different class and wouldn't be pari passu with other senior claims.
Bondholders have lent money to the company just as depositors have, you acknowledge this by talking about the maturity of the bonds. Their rights as a creditor are not determined by the maturity of the bonds they own, but by their seniority. Just as the example I gave of a mortgage and and overdraft.
Making the excuse for the public that they chose a bank because it was close to them doesn't diminish their blame. People who deposited money in risky banks, ignored history, much as reckless Northern Rock did with respect to property prices.
BR, it is a matter of interpretation and also a philosophical point. But a dollop of common sense always helps...
We know perfectly well that there is a sliding scale, between ordinary share capital ('common stock); preference shares; 'mezzanine finance'; contingent convertibles; junior bonds; senior bonds; fixed term savings accounts; deposit accounts and current accounts ('checking accounts').
Somewhere we have to draw the line between 'owners' and 'creditors'. You may draw the line in a different place to me, that's all. I would draw the line at 'fixed term savings accounts'. I consider these to be creditors, but if you twist my arm, I can accept that maybe they are part owners.
What you want to do is give the benefits of 'ownership' and the benefits of 'creditorship' to the bondholders and to pass the drawbacks of 'ownership' and the drawbacks of 'creditorship' to depositors.
I'm a capitalist - who takes the risks gets the rewards; who has reaped the rewards in the past must now take the losses. And yes, foreigners who put their money into Icelandic banks deserve what they get - but Iceland is another country and no concern of mine.
Yes there are hybrid sections of the capital structure, but that is really just in name. The division between an owner and creditor is far more simple than a ratings agency test.
An owner will get a vote and a say in how the company is run, they get a share of profits.
Creditors on the other hand are lenders to the company, they have no say in the way the company is run and they receive interest on their loans. This is both the legal and common sense definition, hence bondholders are creditors and not owners, as are depositors.
By your own definition of being a capitalist, which I am, then you would agree that people having an account with Northern Rock who earnt a superior rate of interest have not paid the price for their foolish lending decision, but you believe that they should be bailed out? why should a company or individual that lent to northern rock on a slightly longer duration be treated differently?
under the FRB system your bank deposits are not loaned to the bank, the bank owns the money when you deposit the funds,thus depositors can in no way be regarded as owners, the depositor has surrendered legal title.
BR, like I'm saying, you and I draw the line in different places. But using your definition, what about the owner of some non-voting cumulative preference shares - is he an owner or a creditor?
"... would you agree that people having an account with Northern Rock who earnt a superior rate of interest have not paid the price for their foolish lending decision, but you believe that they should be bailed out?"
I'm not aware that NR paid higher interest than other banks. And I don't believe that depositors should be 'bailed out' either, where did I ever say that? I said that it makes sense to give them priority in an insolvency.
With the Icelandic banks, it was quite clear that something was a bit fishy as they DID pay much higher interest than other banks, plus UK depositors were 'sending their money abroad'. So I agree that these people accepted higher risks.
S, we were arguing about who is an owner of the bank and who is a creditor.
Oh I see, Shareholders and Bond Holders then.
NR regularly topped surveys for ISAs paying the highest rate of interest. There was zero differentiation by depositors by risk it entirely focused on return.
Pref shares I would say are junior debt. They don't get a vote and are really paid a interest rate rather than a variable percentage of the profit.
The thing is, its not that there are just two classes in bankrupcy, creditors and equity holders. There are several layers in the capital structure in a normal bankrupcy and I'll rank them by usual seniority of claims; senior secured, senior unsecured, subordinate senior debt, sub junior, pref, shareholders. Claims should be paid off in that order, with claims treated equally within their classes. The point is simply that depositors like senior bond holders are members of the senior unsecured creditor class and there should be no priority given to depositors because they are retail.
BR, maybe it is the case that NR paid higher interest, in which case, you are right, that should have acted as a warning signal. But this has nothing to do with the bondholders vs. depositors argument!
" The point is simply that depositors like senior bond holders are members of the senior unsecured creditor class and there should be no priority given to depositors because they are retail."
Thank you, so there is a pecking order, and in strict legal terms you are almost certainly correct. but answer me this: do not bond holders get a slightly higher rate of interest than depositors?
I think yes (or else why would anybody buy them), ergo, if we split hairs, depositors are senior to bondholders. Plus, all these banking acts and regulations are thousands of pages long, is it too much to ask for one clause somewhere that says 'Depositors get repaid in priority'?
See also our banking manifesto (somewhere on this blog).
"I think yes (or else why would anybody buy them), ergo, if we split hairs, depositors are senior to bondholders."
I'll say this again; maturity does not equal seniority. I'll ask you again, by your logic, your credit card would have the first claim on your assets and not a mortgage, do you not see how illogical that is?
A higher interest rate is consistent with several factors; i) the asymmetry between interest rate risk (ie. interest rates can't go lower than zero, so you demand a premium for more interest rate risk you take) ii) uncertainty increasing with time, etc.
If anything I disagree with the idea that depositors should have special legislation (and lets say that we apply this from this point onwards, rather than retrospectively) that we place them ahead of all other creditors. The consequences of this are precisely the cause of the crisis, people making lending decisions ignorant of the risks they were taking. Its illogical to say that banks should face the consequences of their lending decisions, but the public lending money shouldn't be?
BR: "your credit card would have the first claim on your assets and not a mortgage"
Aha, but the mortgage is 'secured' and your credit card is not, as you perfectly well know, and if the credit card company and the mortgage lender have any gumption, they enquire about pre-existing debts first.
"The consequences of this are precisely the cause of the crisis, people making lending decisions ignorant of the risks they were taking.
Its illogical to say that banks should face the consequences of their lending decisions, but the public lending money shouldn't be?"
The banks made the stupid lending decisions (and households made the stupid borrowing decisions - that's Home-Owner-Ism for you); ordinary depositors just chose whichever bank branch was convenient; and bondholders and all these sovereign wealth funds employ 'professionals' to look at what to invest in
As a philosphical point, an ordinary depositor does not make a 'lending decision' in any realistic sense, but an asset manager for a sovereign wealth fund has the time and energy to actually look at the bank's balance sheet; he has the market power to demand further better and details and so on.
An ordinary depositor was not gambling on a credit bubble making him ever richer (it was the house prices that he thought would make him richer); the real people behind the credit bubble were the large money market fund chaps (the banks are just middlemen).
Therefore, sod the existing legal niceties, common sense says that depositors are given priority before bond holders; and if taxpayers have to pay out to depositors, well at least it's just the little people paying out to the little people, it's like insurance.
To force the little people to pay taxes to bail out to the already super wealthy is not insurance, it is theft.
What Bush and Obama and Paulson and Bernanke have done is a massive embezzlement on a massive scale and you know it.
" ordinary depositors just chose whichever bank branch was convenient" well then they were reckless in their decision making, ignorant of history and motivated by sloth and greed.
You recognize the poor decision of buying a house, you recognize the poor decision of lending money to someone to buy a house at a poor price, yet you say that someone lending money to a bank shouldn't have to face the consequences of their actions?
At the same time you say that other creditors of a bank should face the consequences of their actions?
The argument that the super wealthy have been bailed out by the small taxpayers is nonsense, do you honestly think the median household is a net taxpayer? How do you think they would have been effected without any bailouts?
Regardless, advocating retrospective action to make depositors claims senior would be illegal and against common sense. Effectively what you advocate is treating property rights differently depending on the wealth of the holder; surely everyone is equal before the law??
BR: "Effectively what you advocate is treating property rights differently depending on the wealth of the holder; surely everyone is equal before the law??"
May I refer you to my earlier comment:
"It may be, for example, that a load of little mugs have entrusted their £10,000 life savings to a huge pension fund who invests in bank bonds, but all the deposits are held by wealthy, canny, cautious investors with £1 million each. Depositors get priority
It may conversely be that the cautious little people put their £10,000 life savings on deposit and the bonds are owned by super wealthy. Depositors get priority.
Can you see a pattern emerging here?"
I suspect we are agree that if in doubt, it is best not to re-write laws retrospectively. As I also explained above:
"in the UK there is an explicit government guarantee for deposits up to £50,000 (used to be up to £35,000). There is no such guarantee for bonds. Why on earth should taxpayers money be used to bail out bond holders when a debt for equity swap would suffice?"
I find it acceptable for the government to use taxpayers' money to bail out depositors because this was always the law and the understanding - and the people paying the extra tax are by and large the same as the people whose deposit is guaranteed. This is just an insurance scheme where gains and losses net off.
UK and European governments NEVER had a law that said banks generally, or bond holders in particular had a government i.e. taxpayer back guarantee - so by now using our money to bail out bond holders, all these governments - in particular the US and Irish governments - have REWRITTEN the law in favour of bond holders (who tend to be wealthy non-taxpaying foreign institutions) and to the detriment of domestic taxpayers.
Your Chapter 11 insolvency experience is all very relevant to this - is it part of your normal day to day work that you tell the small creditors to get stuffed and to ring up the government to ask them to get the taxpayer to bail out the large creditors?
So while you accuse me (possibly correctly) of retrospectively favouring the little people, what our governments are doing is retrospectively favouring the already super-wealthy. With only so much money to go around, I'd always prefer to risk a few super-wealthy people becoming just 'normally wealthy' than risk millions of 'not very wealthy' people becoming 'poor'.
"This is just an insurance scheme where gains and losses net off."
I agree, the government would and should have honoured its guarantee, however its not a benign policy. It encourages reckless yield chasing behaviour, and led people to incorrectly believe that lending at 6% to a bank is a risk free game. Its not, and it will have allowed irresponsible institutions to raise capital when they should have had to compete properly with people properly judging the risk involved. If the government is going to guarantee funds held on deposit, then they should be held by the government and we should all benefit from borrowing that capital.
"all these governments - in particular the US and Irish governments - have REWRITTEN the law in favour of bond holders (who tend to be wealthy non-taxpaying foreign institutions) and to the detriment of domestic taxpayers."
No.
Bondholders haven't been treated more favourably than other creditors.
The assertion that its the "super wealthy" that have been bailed out is completely unfounded, as is the idea that the institutions that own these funds are for the wealthy, or that they are foreign or don't pay tax. Pension funds, investment trusts, insurance companies, normal companies managing their treasury, etc. These as well as pensioners are all bondholders, all pay tax and all represent normal household wealth.
My experience of chapter11's is that creditors of the same class get treated equally, as they should be, rather than allocating them a share of their assets in order of political popularity. Thank God we have real courts rather than Harman's "court of public opinion".
It seems to me that there is a clear difference between bondholders and depositors in that bondholders are in a far better position to judge the riskiness or otherwise of buying debt from a bank than depositors are of lending money to it. Bondholder are in the financial business, depositors are usually not. In a similar way, lenders to any business are far better equipped to judge the riskiness of their loan than suppliers.
BR, see what Bayard says (that's why he's Prime Minister in the Bloggers Cabinet and not me, he doesn't get bogged down in details).
Bayard,
Bondholders are not priveledged to any information not available to depositors. If depositors are not capable of judging the risks of the decisions they make, then they should not be making those decisions.
So as I said earlier, remove the guarantee for depositors, savers have always had the option of NS&I for guaranteed investments. If depositors want to speculate and buy ISAs from Northern Rock then they must know that their money is risk, rather than feeling the government will come to their rescue.
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