Minyan Mailbag: Bank Dividends Should Be Banned
Days of "all gain, no pain" must end.
Dear Minyan Peter,
As a tight-fisted taxpayer, I like the idea that any relief afforded the Detroit auto manufacturers will be offered as a loan that must be paid back with interest.
However, would one of the unintended consequences of government intervention be higher coupons on corporate bonds issued to the private sector? After all, investors would be taking on the added risk that they could, at any time, be shoved farther back in line by Uncle "Super Senior" Sam.
Dear Minyan Bill,
Your question perfectly captures the Sophie's Choice-style challenge facing Congress as it repeatedly tries to "save" insolvent companies.
If the government lends in a super-senior position, it increases interest expense and further subordinates existing creditors and shareholders. At the same time, if it comes in at the very bottom of the capital structure, the government eviscerates the existing common shareholders and appears to be "socializing" American business.
Over the past year, we have seen the full range of solutions - senior debt, subordinated debt, preferred stock, warrants and common stock. And because of the inconsistent nature of the regulators' response, every investor across the capital spectrum now operates in an atmosphere of fear.
But I think it's worth stepping back for a minute and looking more broadly at the situation. In every bailout -- from Bear Stearns to Freddie (FRE) and Fannie (FNM) to AIG (AIG) to GM (GM) -- the fundamental issue has been an entity with too much debt and too little tangible equity. And in my mind, a huge amount of this debt must ultimately be destroyed - either through repayment, through write-offs, or through a swap of existing debt for new common equity.
In substantially every case of government intervention so far, we have chosen the short-term easy way out: Piling on more debt and/or more preferred stock. And worse, as the economic environment has further deteriorated, and as more and more companies have come to the government for help, we have raised, not reduced, the coupons and dividend rates on these bailouts - thereby saddling already overleveraged companies with greater and greater expense.
At some point, though, this charade will end. And I, for one, had hoped that GM might be the straw that broke the camel's back. Really - would you lend money to a firm with a over $170 billion in liabilities and a negative net worth of more than $60 billion? But alas -- as I was taught a long time ago -- one should never confuse economics and politics.
Ultimately, I believe all bank dividends must be banned, and capital structures must be rebuilt from the bottom up. (And kudos to Gordon Brown's team in the UK for just getting on with it.)
Will it be painful to existing shareholders and debtholders (not to mention employees and suppliers)? Absolutely.
But the days of "all gain, no pain" must end.
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