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Can We Stiff The Bondholders?

I meant to link to this yesterday and just didn't get a chance, but Josh Marshall has a great post raising a lot of important questions about bondholders--in particular, whether they should take a hit (and how big) as we bail out (and potentially nationalize) major financial institutions:  

Now, on the one hand, this sounds like a no-brainer. If you lend money to a company that goes bankrupt, that's tough luck. Maybe you recover a percentage on the dollar of what you were owed. But too bad. Why taxpayers should cover those loses is really hard to answer. But let's try it.

The counter-argument is that if bondholders, especially the most 'senior creditors', take a big hit it, will create a big shock to the financial system worldwide, making bond-investing money extremely risk-averse for a long time and making the credit markets seize up again on far worse a scale than happened last fall in the wake of the Lehman bankruptcy. ...

I come into this extremely suspicious of arguments for why taxpayers need to cover the bondholders' losses. Yes, those bonds are held by pension funds and insurance companies. In broad terms they're held by very, very wealthy people. But I've talked to different economists who I think are pretty on the level on this and they think the systemic risk is very real. And not just huge shocks to the credit markets. The losers aren't just guys in Monopoly suits who hold these bonds. It's your insurance company, your state pension fund, etc. So there's potentially a lot of collateral damage.

Josh and I actually had an offline discussion (actually e-mail--is that considered "online" these days?) about this a few weeks back and I think our views are kind of merging, though I'm still probably slightly more concerned than he is about a global meltdown, and he's probably slightly more galled than I am (though not much) at spending hundreds of billions--maybe trillions--to bail out the bondholders.

The other question is the counterparties, of course. But the tradeoffs seem kind of similar...

--Noam Scheiber