Is the Obama administration guilty of double standards when it comes to dealing with crisis-hit banks and motor manufacturers?
Politicians with ties to Detroit believe that it is. Carl Levin, a Democratic senator, told reporters last week: “There has been a double standard for a long time.”
The political arguments surround the treatment of workers and executives in the two industries. Unions complain about the painful concessions being demanded of employees at General Motors and Chrysler.
Thaddeus McCotter, a Republican congressman, asked why Rick Wagoner was forced to resign as GM chief while no bank chief executive has been ordered to quit by the government.
Tim Geithner, the US Treasury secretary, moved to rebut this criticism on Sunday.
He raised the possibility of firing bank executives and said the government would force banks receiving exceptional aid to undertake “the kind of restructuring necessary for them to emerge stronger”.
But in economic terms, the argument surrounding workers and management is only the tip of the iceberg. The much bigger issue is the way the administration’s strategies allocate losses between shareholders, bondholders and taxpayers.
Here, economists see obvious double standards. The question they ask is whether these are necessary and sustainable in the current political climate.
Both the auto industry and the banking industry have too much debt relative to equity. In the former sector, the Obama administration is demanding debt-for-equity swaps that will impose large losses on bondholders. But in the banking industry, the administration is not asking for debt-for-equity swaps.
Indeed, the administration says it will provide whatever government capital is needed to ensure that banks are able to meet their commitments – which strongly suggests no losses for bondholders. Analysts think that up to $1,000bn (€747bn, £680bn) in additional taxpayer funds may be needed.
“There is a blatant double standard,” said Ken Rogoff, a former chief economist at the International Monetary Fund. “We should do debt-for-equity swaps for banks as well.”
The market is concerned that this argument could catch on. The cost of insuring debt issued by Citigroup against default is higher now than it was on March 9, according to Bespoke Investment Group, even though Citigroup’s share price has more than doubled since then.
US banks have roughly $3,000bn in debt other than bank deposits. Mr Rogoff said swapping long-term debt for equity would fix the financial sector’s problems and shore up public faith in the fairness of a market-based financial system.
Simon Johnson, another former IMF chief economist, agrees. “A lot of people think debt-for-equity swaps are the right way forward for the banks,” he said.
“It would be messy, but it would recapitalise the banks at zero cost to taxpayers.”
The Obama administration and the Federal Reserve categorically reject this approach, arguing that any attempt to impose auto-style losses on bank bondholders would aggravate the credit crisis and inflict terrible harm on the economy.
Without a credible threat of bankruptcy, bondholders would never agree. But banks can self-destruct quickly, so the government might have to seize banks before threatening creditors. Doing so would be legally complicated and could harm their business value.
Policymakers scarred by the devastating impact of Lehman Brothers’ uncontrolled collapse last year have all but ruled out further experiments with bankruptcy of financial institutions.
However, Hal Scott, a Harvard professor of international finance, said: “The problem with Lehman was what happened to counterparties not what happened to creditors.”
Congress will soon discuss legislation to give the authorities emergency powers that could help them to differentiate between counterparties and creditors in bankruptcy.
The legislation is designed for the next crisis, but Mr Johnson said it should be used to resolve the current one. “At that point you can force people to do debt-for-equity swaps,” he said.
However, the proposed new powers would not deal with cross-border fallout from a global bank’s failure.
Raghuram Rajan, a third former IMF chief economist, said changing the rules mid-crisis would be damaging.
Losses on bank bonds held at par could destabilise pension funds and insurance companies and could force the government to issue more guarantees.
“Let’s not take our eyes off the central concern, which is stabilising the financial system,” said Mr Rajan.
“If the banking system remains dysfunctional for another three or four years the cost will be much higher than any benefit you get from inflicting losses on the bondholders.”
But Mr Rogoff gave warning that it might be impossible to muster enough funds to fix the banks if bondholders did not chip in.
“My biggest objection is not the fairness issue,” he said. “It’s that if the government relies only on taxpayer funds it will end up in the trap of doing too little, and this may not be enough to get the financial system working again.”
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