American taxpayers and stock owners have taken it on the chin in this financial crisis. The same can't be said of bondholders who lent money to the most troubled banks.
The Obama administration is now ordering General Motors Corp.'s creditors to make sacrifices to save the ailing automaker. Yet bondholders of financial companies such as Citigroup Inc. and Bank of America Corp. so far have been mostly left off the hook, even though the government has given the banks billions of dollars in bailout money.
Many those bondholders, in fact, are still profiting from their investments so long as they haven't had to sell, while the rest of us deal with vanishing wealth.
"The sum total of the policy responses to this crisis has been to defend the bondholders of distressed financial institutions at the public expense," said John Hussman, who runs an investment firm in Ellicott City, Md.
Hussman is among critics who say bank bondholders shouldn't be shielded from all that has gone wrong in the past two years. "When one lends money to a financial institution, one also assumes the risk and responsibility of bearing the losses," Hussman observed.
The White House has been sending out the same message as it turns up the heat on GM's creditors. In addition to forcing CEO Rick Wagoner to resign, Obama administration officials told GM bondholders over the last week they must make concessions or else the automaker will be headed for a bankruptcy reorganization that likely would diminish the value of their holdings.
Creditors of GM, which has received $13.4 billion in federal loans, had been balking at restructuring their debt, betting the government wouldn't dare force the giant automaker into bankruptcy. But White House economic adviser Austan Goolsbee called their bluff: "They're going to have to make some sacrifices," he said in an interview on CNBC.
Too bad bank creditors aren't under the same pressure. They're still living in a financial world of the past, where corporate bond investors — whether they be individuals, pension plans or hedge funds — loan companies money and get regular interest payments. If they keep the investment until it matures, they reclaim their principal.
For example, investors who took part in a $1 billion 30-year bond offering by Citigroup in 2002 are still being paid a 6.625 percent yearly return on each $1,000 invested and are scheduled to be paid back in full when the bonds mature in 2032. If they sold now, they would get about half that value since bonds of that vintage are currently trading at around 56 cents on the dollar.
Federal officials have been reluctant to force any changes to the terms of bank debt. That's because they fear setting off another global financial panic — much like what happened after the collapse of investment bank Lehman Brothers last September — by suddenly altering bondholder agreements.
Bank creditors also are harder to push around. If they're forced to take haircuts on their investments they could threaten to close off future lending to banks, cutting off a vital supply of oxygen to financial service providers who depend heavily on debt to fund their operations.
Consider that about 20 percent of the $12.5 trillion in liabilities on bank balance sheets at the end of 2008 came from corporate bonds and other debt vehicles, according to data from the Federal Deposit Insurance Corp.
At a company like Citigroup, about $500 billion of its nearly $1.8 trillion in liabilities comes from debt to the company's bondholders. Citigroup has received $45 billion in rescue funds from the federal government.
That doesn't mean bank creditors couldn't take action on their own, say, offering to restructure the debt of the most distressed companies in order to help them stay alive.
If those investors are willing to convert some of their debt into equity, the effect could be huge. That could encourage banks to lend more by reducing the claims debtholders have on their capital.
It's the same thing Washington wants from GM's bondholders. Too bad we can't count on the same from bank creditors.
Copyright 2009 The Associated Press.