It is time to stop talking about troubled banks’ share prices. True, there is a danger that concerns for nationalisation become self-fulfilling: pummelled stock prices reinforce fading confidence in a bank, thus increasing the likelihood of intervention. But when Citigroup – supposedly first in the line of fire – trades below $2 a share, its equity value is moot. The real debate is further up the capital structure.
Confusion over what is meant by nationalisation has created a muddle. US dislike of forcibly seizing ownership and control makes this a last resort. Instead, a halfway house is possible, as with Royal Bank of Scotland, where conversion of the UK government’s preferred shares to common equity gave it control.
Even so, with the cost of protecting Citi’s debt against default approaching all-time highs, debt investors face vast uncertainty. For instance, if dividends to common stockholders were stopped, holders of hybrid securities risk being left with debt zombies: uncalled bonds paying no coupon. Seemingly mindful of this, the Obama administration’s stability plan limited banks to paying $0.01 in quarterly dividends as any payout at all requires senior debt obligations be honoured. RBS has continued payments on hybrid securities – perhaps to avoid knock-on effects in the portfolios of pension funds and insurance companies.
At the crux of the debate is the issue of whether senior unsecured creditors take a hit. If a bank’s shortfalls wipe out equity and subordinated debt, either taxpayers or bondholders must absorb any further losses. Outright nationalisation is cheaper if creditors suffer. But their punishment was widely derided as a mistake when Washington Mutual and Lehman failed. To do so again could upend bond markets. Companies must raise money somewhere. Hence Alan Greenspan’s call to protect senior debt as financing’s “anchor”, a notion reinforced by government guarantees on $260bn of recently issued bank debt. Ad hoc crisis management last year stoked market panic. Depositors are now presumed safe while shareholders are toast. It is time to spell out where everyone else stands.