Bankia and the Benefit of Bondholder Losses

Bankia’s Balance Sheet

I’m not sure how much I trust any of the data on Bankia since I am always dubious of anything that was cobbled together in a state of panic, but let’s take a look at some of the numbers that are out there:

Total Assets: €303 billion.

Long Term Borrowings and Liabilities: €61 billion

“Equity”: €12 billion. Okay, this number is laughable, but is the official accounting version. Current market cap is only €1.2 billion.

That leaves depositors and short term borrowings of about €230 billion.

The Benefits of Hitting Bondholders

Recapitalizing Bankia is a huge effort. It is a big bank, with questionable assets. How much of an equity investment would it take to shore up Bankia to the point where real investors would feel comfortable enough to lend them money in the bond market? Not investors willing to lend on the basis that the government will bail them out, but because they believe the bank has enough capital?

That is one of the major problems with what has gone on so far. Banks get the absolute minimum capital required because the governments don’t want to put much money at risk. That makes sense. The governments then expect bond markets to react positively “knowing” that the governments are there. That makes no sense. Most bond investors will not buy based on an implicit hope that a government will continue to prop up a fragile bank. It doesn’t work that way.

That leaves governments with two choices, put in so much equity that the banks are truly well-capitalized, or make existing lenders take a loss. Those really are the only two choices once you realize that the “bare minimum capital to pretty it up for a bit” policy doesn’t work.

Governments cannot and should not be bailing out all investors. In an ideal world these banks should have been allowed to fail long ago. Banks should have been allowed to fail back when the system wasn’t so fragile but even now, if “failure isn’t an option” the governments must truly recapitalize the banks and make the system sustainable at the lowest cost to the taxpayer as possible. Forcing bondholders is a big step towards that.

Forcing depositors to take a loss is more questionable. In theory I agree with the concept, but given the EU’s reliance on short term debt, and the nature of depositors, that can probably not be done in this environment without triggering a full scale bank run.

With €45 billion of bonds outstanding, Bankia could easily reduce the amount of equity needed by forcing these bondholders to take a haircut. It does seem “unfair” to treat all the bondholders equally as these are typically legacy bonds of the original issuer, but I’m not sure how easy it is to prove which Caja was worse than the other so it might just have to be across the board.

If bondholders were forced to lose 1/3 of their investment in a restructuring, that would knock €15 billion off the long term debt load and would reduce the amount of government equity investment.

The biggest pool of untouched capital for bank restructuring is the debt they issued. Forcing bondholders to lose, in cases where they should, in a reasonable way, would be a big step.

Triage and Panic

One concern about forcing bondholders to take a hit, has been the question about what the consequences of the losses will be. But rather than avoiding the consequences, we should encourage them and deal with them. If some big bank, Spanish or otherwise is affected by the debt restructuring, so what? €15 billion of losses on Bankia debt would get spread through the system. Not every holder who takes a loss will need a bailout themselves. Would it hurt the stock price of banks that hold the debt? Definitely, but if it is a DB or BBVA, it is a mere blip. Some pensions will be hit, but again, pension reform needs to be taken and pretending all of their investments are “money” good is not helping that process.

Will some of the losses cause a ripple that needs to be addressed? Probably, but so long as large portions of the losses are disbursed throughout the system, the total cost of the bailout, including the ripple effect will be a lot less for the government.

Not only is the benefit large, but the costs are shared appropriately. Financial transaction taxes have been discussed as a way to pay for the bailouts. Sure, all banks have benefitted from the myriad of central bank policies, but I would rather see those that made the worst investment decisions punished the most, and that is best done through forcing bondholders to lose money in the banks that need massive amounts of recapitalization, and dealing with the consequences as they appear.

Will there be some initial panic to this “triage” approach? Maybe. Maybe someone will become afraid that BBVA will take a hit, but then common sense will prevail. Banks that don’t need massive injections of public funds should not see their bondholders hurt. The market is rational and will figure that out.

So, the best outcome is to force bondholders to take a hit when banks need big capital injections from governments, and to deal with the consequences as necessary rather than avoiding the consequences altogether.