CIAO DATE: 12/2014
November 2014
Peterson Institute for International Economics
Bail-ins and creditor haircuts have long been a feature of resolutions and recapitalizations when banks have become, or are on the verge of becoming, "gone" concerns. The public outcry against taxpayer bailouts has led to the development of something new-the automatic bail-in of creditors of institutions that are still "going concerns." Bail-in securities, commonly known as cocos (contingent, convertible capital instruments), convert into equity once a bank's capital falls below a preannounced level. Even before the ink is dry on regulators' proposals, banks have started to issue cocos and the market has quickly grown to a capitalization of $150 billion. Bail-in securities may make sense for an idiosyncratic bank failure. But they do not make sense in the more common and intractable case where many banks get into trouble at roughly the same time as the assets they own go bad. On such occasions these securities, which may also have encouraged excessive lending, either will inappropriately shift the burden of bank resolution on to ordinary pensioners or, if held by others, will bring forward and spread a crisis. If more gold plating of bank capital is what is required, then this fool's gold will not do.
Resource link: Why Bail-In Securities Are Fool's Gold [PDF] - 304K