In his latest market commentary ("Buckle Up") Dr. Hussman reiterates his call for the government to make bank bond holders take eat some losses:
The misguided policy response from Washington has focused almost exclusively on squandering public money and burdening our children with indebtedness in order to defend the bondholders of mismanaged financial institutions (blame Paulson and Geithner – I've got a lot of respect for our President, but he's been sold a load of garbage by banking insiders). Meanwhile, I suspect that the little tapes in Bernanke's head playing “we let the banks fail in the Great Depression” and “we let Lehman fail and look what happened” are so loud that he is making no distinction about the form of those failures. Simply letting an institution unravel is quite different from taking receivership, protecting the customers, keeping the institution intact, replacing management, properly taking the losses out of stockholder and bondholder capital, and issuing it back into private ownership at a later date. This is what it would mean for these banks to “fail.” Nobody is advocating an uncontrolled unraveling of major financial institutions or permanent nationalization as if we've suddenly become Venezuela.
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The course of defending the bondholders of insolvent institutions is not sustainable. Do the math. The collateral behind private market debt is being marked down by easily 20-30%. That debt represents about 3.5 times GDP. That implies collateral losses on the order of 70-100% of GDP, which itself is $14 trillion. Unless Congress is actually willing to commit that amount of public funds to defend the bondholders of mismanaged financials so they can avoid any loss, this crisis simply cannot be addressed through bailouts. Bondholders have to take losses. Debt has to be restructured. There is no other option – but the markets are going to suffer interminably until our leaders figure that out.
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Yes, some pension funds, insurance companies, mutual funds, and other investors who hold the corporate bonds of mismanaged financial institutions will take a haircut on those investments. As they should. But if we ignore the need to restructure debt obligations, we risk allowing this downturn to move aggressively into 2010.
The dot drawing of Hussman above comes from a Wall Street Journal article about him last week, "Outfoxing a Bear?". Hussman linked to this article in his market commentary.
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In his WSJ column today ("Buffett's Unmentionable Bank Solution"), Holman Jenkins seconds Buffett's view that with some forbearance from regulatory capital requirements, banks will be able to use their current wide spreads to quickly rebuild equity. He also argues that the way to prevent moral hazard in the future is to make bond holders and unsecured creditors (e.g., depositors above the FDIC limit) take a haircut.
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