Bail-in never never land
After the 2008 crisis, regulators promised that bondholders would suffer haircuts when banks next needed recapitalisation. The idea was to cut the burden on taxpayers and use bond market discipline to force banks to run fewer risks.
But as Europe gears up for the next big capital injection exercise, it looks like taxpayers will again be picking up the tab. Witness the weekend bailout of Dexia, the Franco-Belgian bank. Governments are so scared of contagion that it will be hard to impose losses on bondholders unless some key protections are put in place rapidly.
The contagion argument was already used by banks successfully last year with respect to Irish banks. The European Central Bank prevented the Irish government from haircutting bondholders out of fear that senior creditors in banks elsewhere in Europe would get the jitters – making it impossible for even healthy banks to raise funds. That argument appears even more powerful now given the fragility of the banking system. Contagion wouldn’t just be via sentiment. As banks hold each others’ debt, losses would spread through the system.
It is not, though, too late to bail in bondholders – provided decisive steps are taken to stop contagion. This comes down to having adequate mechanisms to recapitalise and provide funding to all the healthy banks. The euro zone is inching in the right direction – with plans not just to recapitalise its banks, but also to use the European Financial Stability Facility (the region’s bailout fund) to help those countries which aren’t strong enough to support their banks. But the approach is still full of holes: the size of the bank recaps, the firepower of the fund, the terms for using it and the nature of any supporting liquidity injections from the ECB are still up in the air.
If policymakers can’t nail all this down quickly, it will indeed be too risky to bail in the bondholders. Taxpayers will have to groan under the burden again. And regulators will have to accept that the idea of making creditors share the pain will have to be postponed until the next crisis – or, indeed, to never never land.