Today the EU issued a discussion paper about how it plans to forcibly write down the debts of shaky banks if it ever comes to that, which for some reason is called a “bail-in,” I guess in the sense that the bailing is coming from creditors who are already in the bank’s credit rather than from taxpayers who aren’t. It’s pretty interesting, go read it, or read Bloomberg’s piece about various bits of squabbling over it and also somewhat counterintuitively a statement from EU guy Michel Barnier (left!) that “There’s a big international consensus on the principle.”
Actually there probably is; the principle is pretty sensible, which is that there comes a time in many companies’ lives where the best way to preserve value not only for the enterprise but also for the creditors is to write down some of the debt to allow the company to continue as a going concern that can pay off the rest of the debt. This is why we have bankruptcy, but bankruptcy seems to be too slow and scary for banks. The worry is, you have a bank and it’s got like $15 of equity and $100 of debt and its assets go from $115 to $90 and all of the debt holders start looking at their watches and being all “hey this has been fun but I’m actually late for this thing so would it be too much trouble for you to give me my money back?” and the bank has to sell a bunch of stuff to meet those demands then that looks like a fire sale and people figure it out and all of a sudden that $90 becomes, like, $60, and the debtholders get back 60 cents on the dollar instead of the 90 cents, and they’re like “crap, if I’d just said ‘I’ll take $90, and also whenever you have it is fine, no rush,’ I’d have much more money.”
Of course that’s all sort of obvious so one thing that the creditors could do is just not do that, and voluntarily and quickly write down their debt so that the bank wouldn’t have to have a fire sale to meet their claims, but, knowing creditors, that’s not what would happen, so you need some sort of resolution mechanism to protect them from themselves. Read more »