Unfortunately, the private sector approach to reorganizing and recapitalizing banks, forced debt-to-equity conversions, is too harsh on creditors. Yes, it is the free-market solution, and it's what we normally do (via the bankruptcy process) when firms are viable but undercapitalized. But, we are afraid of hurting lenders at a moment where credit markets are wobbly and a strike by lenders could be catastrophic. Okay.Well, maybe and maybe not. But it's the kind of idea that ought to be in play.
Maybe these are two great tastes that taste great together. What if both the state and junior creditors could took equity stakes in reorganized firms, fifty-fifty. The former creditors would run the place without government interference, isolating management from politics and diminishing concerns of creeping socialism. Taxpayers would enjoy the upside as passive investors in ordinary, profit-maximizing businesses, and would buy shares at a bargain price (book value after very aggressive write-downs have been taken). Some creditors would still have to endure the indignity of being converted to equity, but the amount of debt that would have to convert would be cut in half (approximately), giving converted debtors a lot of capitalization bang for their buck. Junior creditors would go from owning very dodgy debt to relatively safe shares, and more senior creditors would see the value of their positions spike and stabilize and solvency concerns abated.
Tuesday, September 30, 2008
Waldman on Taking Equity
Steve Waldman at Interfluidity is becoming a must-read, because he addresses the questions to which I want answers. Here he tackles the matter of "taking equity" (link):