Banking regulators have struck upon the latest way in which bank collapses won’t wind up leaving taxpayers with an enormous bill. In short, there should be a new holding company, in between the parent holding company and its subsidiaries. That way, when the bank goes bust, only the parent holding company dies, wiping out its shareholders, while leaving the bank’s actually operating businesses unscathed, at least in bankruptcy terms. This is accomplished by the new holding company selling a ton of debt, the proceeds from which go to the operating subsidiaries. The new creditors then become shareholders of the post-bankruptcy bank, and the whole thing starts over again.
Cute, to be sure. But will it work? Of course not.
We ask two crucial questions. First, who is going to buy these new bonds? And second, how likely it is that forcibly converting bondholders to shareholders will do the trick in a financial crisis?
On the first point, the worry is that retail investors might be the ones most likely to hold this new debt. That means that the taxpayer may be left holding the bag once again. At the least, we will want to make sure that investors understand this up front and demand an appropriate return.
On the question of the “single point of entry” approach, the basic issue is whether it is reasonable to think that the near failure of the American International Group in 2008, to take but one example, could have been contained by restructuring its holding company.