In essence, these bailouts give bondholders more protection than they’d otherwise see — at stockholders’ expense.
It’s probably true that “something had to be done” in the case of AIG, the nation’s largest insurance company with operations in 130‐plus countries. But doing something could have meant doing something else — such as offering a secured bridge loan while AIG engaged in some orderly asset sales.
As it is, the US government is charging AIG an interest rate above 11 percent for a well‐secured two‐year loan of $85 billion. That rate properly includes a fat risk premium above the Treasury’s two‐year borrowing cost (about 2.2 percent) — but the government is also greatly diluting AIG stockholder equity by taking a 79.9 percent stake in the company.
The nation’s largest insurance company has been virtually nationalized, surely a draconian solution.
These surprises are always rationalized as a means of “stabilizing markets” or “restoring confidence” — yet the AIG deal is not the first “bailout” to inspire more terror than calm.
Left alone, financial markets usually work out the best possible deals among competing interests. Whenever the feds have gotten involved, by contrast, they’ve taken sides in the tension between stockholders and creditors — invariably throwing stockholders overboard.
Owners of common stock are supposed to be last in line during an actual bankruptcy, getting leftover scraps after creditors pick a firm’s assets to the bone. But in anything short of that, patient stockholders stand a decent chance of eventually seeing some recovery in the share price, if and when the firm gets back on its feet.
And in the recent crises, bankruptcy was involved only in the case of Lehman — the one time the feds kept their hands off.
From Treasury Secretary Hank Paulson and Fed chief Ben Bernanke on down, top officials have shown too little confidence in markets and too much confidence in themselves. As a result, anyone who’s still holding stock in a financial firm now faces a big new risk premium — because these companies are now subject to compulsory mergers on unfavorable terms (as with Bear Stearns, where the feds initially tried to force stockholders to take just $2 a share) or quasi‐nationalization.